Glossary of Legal Terms for Startup – What an Entrepreneur Must Know By Heart
ARTICLES OF ASSOCIATION: This is the document that sets out amongst others, the startup’s internal management rules, authority or powers of the company directors and members and the rights of its members in particular to be notified of, attend and vote at meetings and to receive dividends on their shares if declared. In Malaysia, the startup may adopt a readily available format of the Articles of Association in Table A of Schedule 4 of the Companies Act 1965.
AUTHORISED SHARE CAPITAL – Authorised share is the maximum amount of share capital that a startup can issue to its shareholders. The amount and type of authorised shares is set forth in the MEMORANDUM OF ASSOCIATION, the wordings as follows:
“The capital of the Company is RM100,000 divided into 100,000 ordinary shares of RM1.00 each”.
The startup can change the amount and type of authorised share capital with the shareholders’ consent.
CALL OPTION – the holder of a call option (buyer) (“A”) has the right to require the other party or parties (“B”) to sell their shares to the buyer at a price based on a predetermined formula or fair value. To illustrate this, please see the following:
The Call Option Holder must not necessarily buy the shares – it is not an obligation, it is a merely a right that he can invoke.
CONDITION PRECEDENT – In the DEFINITIVE AGREEMENTS, the investor sets certain conditions that must first be met by the startup and the founders before the funding is released to the startup. Some examples of conditions precedent are, completion of DUE DILIGENCE and that the investor is satisfied with the same, signing of DEFINITIVE AGREEMENTS and capitalisation of advances by shareholders.
CONVERSION RIGHT – rights by which preference shares convert into ordinary shares based on a pre-agreed conversion rate. This right can usually be exercised by a holder of preference shares at any time.
DEFINITIVE AGREEMENTS – This refers to the set of agreements that the investor requires the startup to sign before the funding is disbursed. Definitive Agreements normally comprise the Subscription Agreement, the Shareholders’ Agreement, Call Option Agreement and / or Put Option Agreement (this depends on the terms of the deal structured), the Employment Agreement and the Intellectual Property Assignment Agreement (if applicable). The signing of the Definitive Agreements is one of the conditions precedent to the investment by investor.
DIVIDENDS – distribution of a portion of a company’s available profit to its shareholders, decided by the board of directors (subject to any legal restrictions).
DRAG ALONG RIGHTS – This is the right of a majority shareholder, where if it wishes to sell its / his shares in the company to a third party, it can ‘drag along’ (in other words, force) the minority shareholders to sell out to such third party.
DUE DILIGENCE – A due diligence on the startup is the most critical component of the conditions precedent in investment. Due diligence means the process where the investor conducts investigation into the startup and looks into the company’s business, management, technology, financial, taxation and legal. The startup is to provide all documents and information / confirmation to the investor and warrants that such documents and information / confirmation are true and accurate. Once the due diligence is completed, the investor will form an assessment as to the viability of the investing into the startup.
EQUITY – the value of an ownership interest in a company, usually in the form of shares.
INTELLECTUAL PROPERTY – right that is presumed to represent an advantage to the company’s position in the marketplace, including patents, trademarks, trade secrets, copyrights and licences.
INITIAL PUBLIC OFFERING (IPO) – the process where the private company offers its shares to the public. The process is highly regulated by the Securities Commission and Bursa Malaysia Securities Berhad and corporate advisors will advise on the IPO.
ISSUED SHARE CAPITAL – Issued share capital is the number of authorised shares that the startup has issued to the shareholders. The shares to be issued cannot exceed the number of AUTHORISED SHARE CAPITAL.
ALLOTED CAPITAL – An allotted capital is that part of the AUTHORISED SHARE CAPITAL which has been allotted to shareholders.
MEMORANDUM OF ASSOCIATION: This document is a legal document and is to be lodged with the Companies Commission of Malaysia during the incorporation of the startup. It sets out the main objects of the startup’s business.
MEMORANDUM & ARTICLES OF ASSOCIATION – For the incorporation of the startup, the startup must file the MEMORANDUM OF ASSOCIATION and the ARTICLES OF ASSOCIATION with the Companies Commission of Malaysia. The MEMORANDUM OF ASSOCIATION and the ARTICLES OF ASSOCIATION are legal document that bind the shareholders and they can be amended provided that the shareholders agree to such changes.
ORDINARY SHARES – Ordinary shares represent equity ownership in a limited company and is also known as ‘non-preference shares’. A holder of ordinary share can exercise one vote per share on a poll on any resolution put to a meeting. If the company is wound up, the holder of ordinary share is entitled to participate in the proceeds of the company’s assets after all the debts have been paid.
PREFERENCE SHARES – shares in a company which give the holders an entitlement to a fixed dividend but which do not usually carry voting rights. If a company is wound up, preference shares are usually repayable at par value and rank above the claims ordinary shareholders.
RIGHT OF FIRST REFUSAL – This is the right of existing shareholder against other shareholders, in the event (i) any other shareholder sells its shares (in which case, such existing shareholder has the right to acquire those shares before an outside party can); (ii) the company allots further shares (in which case, such existing shareholder has the right to be allotted with the new shares, before the company makes the offer to outside parties). This right of first refusal is exercised in proportionate to the shareholders’ stake / shareholding in the company.
PRE-EMPTION RIGHTS – a private company may have its Articles of Association (and they may be repeated in a shareholders’ agreement) a provision that any issue of shares may not be made without the shares first being offered to existing shareholders.
PUT OPTION – the holder of the put option (seller) (“A”) is given the right to require the other party or parties (“B”) to purchase the seller’s shares based on a specified and predetermined formula or at a fair value and within a specified period. An illustration is as follows:
REDEMPTION RIGHTS – the investor’s right to force the company to purchase shares.
SHAREHOLDERS’ AGREEMENT – a contract between the shareholders of a private limited company, defining their mutual obligations, privileges, protections, rights and usually comprising the company’s Articles of Association.
TAG-ALONG RIGHTS (Co-Sale Agreement) – obligation on the majority shareholder to include the minority’s interest in any sale it makes to a third party. The minority shareholder has the right to join the transaction and sell his or her shares in the company.
TERM SHEET – Term Sheet is a document outlining the terms of the offer of the funding from the investor. Once the terms of the term sheet are agreed by the startup and investor, the investor will carry out the DUE DILIGENCE on the startup. If the conditions to the investment are fulfilled to the investor’s satisfaction, the DEFINITIVE AGREEMENTS are then signed and funding is subsequently disbursed.
WARRANTIES – specific statements in relation to the company given by the directors of the company (or in the case of share sale, the sellers) to investors purchasing shares or acquiring shares in the company, as an assurance to the worthiness and state of the company.