Canada: Key Legal Issues For Tech Startups – Spring 2019

Last Updated: June 3 2019
Article by Joseph Gill

By some numbers, private sector investment in the Saskatchewan tech sector in the 18 months leading up to January of 2019 is upwards of $13 million (with notable exits and Series "A" raises in the tens and hundreds of millions of dollars). Furthermore, Saskatchewan's two technology business incubators, Co.Labs (in Saskatoon) and Cultivator (in Regina), are providing accelerator programs and mentorship to tech startups. Despite all this support, tech startups still encounter innumerable legal issues. Set out below are the top legal issues that our firm has dealt with on behalf of Saskatchewan tech startups:

Founder Arrangements

For any startup with more than one founder, a unanimous shareholders' agreement (USA) (or partnership agreement if you are a partnership) is a must. Startups should consider this like a "corporate prenup" as it touches on the fundamentals of the relationship among the founders (and investors). A USA is almost always a requirement by investors (whether angel, private equity, or venture capital). Key things that need to be addressed in any USA:

  • Who gets to appoint directors (e.g. every shareholder having more than 10% of the shares)
  • Rights of first refusal if a shareholder wants to sell its interest in the startup (e.g. shareholder must first offer its shares to other shareholders before looking to a third-party sale)
  • Pre-emptive rights for certain shareholders (e.g. founders, strategic investors) to acquire shares as part of future equity raises
  • "Drag-along" rights to force shareholders into an acquisition transaction where several other shareholders agree with that transaction (e.g. 75% of shareholders agree so the other 25% get "dragged along")

Planning For and Accessing Capital

Preparing a proper capitalization table is key for a tech startup (check out www.captable.io as one example). You need a firm understanding of how the ownership of your startup will change with each equity raise (i.e. what are you as the founder willing to give up to bring in new investment). You'll also want to pay attention to:

  • Type of Security ~ Are you going to offer common equity, preferred equity, convertible notes, simple agreements for future equity (SAFE), cryptocurrency, or something else? For a primer on this (and template documents), be sure to check out the National Angel Capital Organization's website: nacocanada.com/cpages/common-docs.
  • Investors ~ Aside from good old-fashioned bootstrapping, startups are generally limited to raising capital from (i) friends, family, and close friends or close business associates, and (ii) accredited investors. For the former, watch out for stretching too far what a "close friend" or "close business associate" is. For the latter, you'll be looking for people who either (i) make $200,000 annually (or $300,000 when combined with a spouse), or (ii) have over $1,000,000 in liquid financial assets or over $5,000,000 in net assets.
  • Government Funding ~ There are a host of provincial and federal programs that startups can access. Be sure to check out the Innovation Saskatchewan website for a running list of most of the big programs: https://innovationsask.ca/technology/funding-options-for-technology-companies-

Employees and Contractors

The key here is documenting the terms of employment or engagement (or you risk a dispute later on). This is especially critical if you are coaxing the person into your startup by way of stock options. Be clear about responsibilities, deliverables, work hours, etc.

In addition, beware the trap of claiming everyone on your team is a contractor. The reality is that most team members that the founders direct or control are legally employees. Failing to realize someone is an employee can cause employment standards as well as tax problems for the startup. A proper legal analysis of the individual's job as well as written documentation is the best approach to avoid this pitfall.

Intellectual Property (IP)

Aside from exploring whether trademark and/or patent protections should be pursued for your startup, you should ensure that:

  • founders and other key individuals forming the "brain trust" of the startup are assigning all their IP rights over to the startup
  • employees and contractors are disclaiming all IP rights in the deliverables they create for the startup
  • partners and other collaborators are signing non-disclosure agreements that protect any IP that the startup passes to the potential partner

At McKercher, we have groups of lawyers focused on startups and entrepreneurs in the Saskatchewan tech ecosystem. We have assisted tech startups with everything from initial incorporation through seed round and series financing and finally to exit transactions. We are also proud to offer fixed-fee solutions to help keep costs in check during the critical start-up phase of a business.

Originally published in Industry West

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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