THIS week the World Bank released the 9th edition of its Tanzania Economic Update series, with the theme Money within Reach – Extending Financial Inclusion in Tanzania. Under part one of this latest edition, the World Bank points to three key areas that require attention for building on Tanzania’s growth momentum.
One of those key areas is the need to unlock the growth potential of the private sector. The World Bank update notes that “there is no alternative to private sector-led growth to reach the levels of investment, employment and poverty reduction that will fulfil the aspirations of the Tanzanian people”. It calls for capacity enhancement to leverage private sector resources into key investments and for access to affordable finance—which weighs down on growth of businesses, particularly SMEs and start-ups.
As Tanzania heeds call for unlocking the country’s private sector potential and for expanding access to finance, it will see its economy modernize and the number of start-ups and entrepreneurs surge—all other factors e.g. peace and political stability remaining constant.
Here, a good start-up savvy lawyer can mean the difference between stretching the limits and breaking Tanzania’s policies, laws and regulations. Yet, many start-ups and entrepreneurs struggle to decide when and why they should retain a lawyer and how to fully utilize their lawyer’s knowledge, skills and experience the moment they do.
I should mention now that being a start-up lawyer is like being “consigliere” Tom Hagen in my all-time best movie The Godfather. But to achieve that depth of trust, a lawyer needs to understand the sacrifices start-up founders/entrepreneurs go through to develop their businesses.
Likewise, more than just technical legal advice, the good start-up lawyers are curious to understand your vision, your business and your industry; and are pretty ready and willing to leverage their own clout with the government of Tanzania and reputed private-sector leaders on your behalf.
However, when it comes to retaining a lawyer, the most obvious perceived red flag is excessive legal costs. But the good news is lawyers who often work with start-ups recognize that most start-ups are, at different stages, cash-strapped. That does not imply good start-up lawyers’ services are low-cost; on the contrary, they offer flexible billing terms for their clients.
For instance, except for up-front payment of out-of-pocket expenses, such as, where applicable, fees for official searches, filing, couriers and information services and incidentals, start-up lawyers will allow to receive their legal fees over time on a deferred payment basis. In so doing, they try to be a ‘business partner’ with you, helping you to grow your business.
Successful start-up founders I have worked with over the past 11 years of my legal career had the erudition to grasp the importance of legal issues. This helps to avoid many of the costly pitfalls others encounter further down the line.
So, at what point should you retain a lawyer?
Conventionally, it’s time to retain a start-up lawyer when you have co-founders and need to distribute equity; safeguard your intellectually property; recruit, fire and remunerate staff; convene board meetings; ensure directors and senior managers fulfil their duties to shareholders; comply with statutory regulations; and negotiate and enter into agreements and memoranda of understanding with other entities.
One of the most common legal pitfalls that can beset start-ups is founder break-ups. Proclaiming a wish to split up and consequently dissolving a business can be horrible, as tempers and feelings run high. How you approach the situation can mean the difference between a cordial and a chaotic split.
Of course, the best way to deal with a founder break-up is by consulting a good lawyer, who will carefully craft your operating agreement provisions on how a break-up would be handled in the most amicable fashion possible, in advance when you’re just launching.
Intellectual Property Rights
This is another common legal pitfall of start-ups. For all start-ups, Intellectual Property Rights (IPRs) are incredibly important. The IPR regime in Tanzania is regulated by two separate and independent legal systems because IPRs are not “union matters” and hence, for IPR protection, Tanganyika and Zanzibar are two different jurisdictions.
That said, IPRs can exist in various forms: they can be an invention, trade secret, software, a brand name or customer database. So, it’s crucial for start-up founders to ensure they avoid the IPRs pitfalls that others frequently fall into.
To avoid IPR pitfalls and maximize future value, founders should try to work with a lawyer to lay a solid IPRs foundation for correctly protecting, strengthening, and commercializing their IPRs, even prior to establishing a start-up.
Equity allocations to founders
Besides founder agreements and IPR protections, a start-up lawyer will also assist you with Company Share Option Plans (CSOPs) and equity agreements. A lot of people start businesses with family, relatives, friends and co-workers for various reasons. Unfortunately, there comes a time when one founder – either for personal or operational reasons – decides to throw in the towel.
Hence, when allocating equity, you have to work out the real or perceived value each individual contributes to the business. A good lawyer will help you institute a credible, detailed vesting schedule with appropriate protection when the founder’s involvement with the business ceases, for instance, through termination or resignation.
Business structure or entity
An inappropriate business structure or entity can cost valuable time. A lawyer will help you understand the spectrum of business structures from which you may choose. He or she will also explain the legal and tax implications of each type of business structure.
The good start-up lawyer will start by inquiring on the nature of business you would like to launch and your expected sources of funding before recommending the best type of structure that allows you to reduce liability exposure, minimize taxes, and ensure that the business can be financed and run efficiently.
Salaries for start-up founders
The issue of start-up founder salaries is an equally common pitfall. An objective and knowledgeable lawyer can help you with the salary accrual set up through a clear, transparent and equitable arrangement.
If a business has been operating without making any revenue, you may need to assign a founder’s contribution to the business in the form of time, effort and skills so that sweat equity compensation can be made in the event of an exit or buy-out of a founder’s interest. Salaries should be paid in cash, not equity.
Miscategorizing employees as independent contractors
Start-ups need to have a thorough understanding of their obligations prior to hiring an employee or engaging the services of an independent contractor. At the outset, it’s critical to determine which category best meets your business and operational needs.
Categorizing your full-time General Manager (GM) as an independent contractor and just allocating him or her equity will not satisfy the Tanzania Revenue Authority (TRA). The TRA will ignore an individual’s designation as an independent contractor if there are indications that the individual is, in fact, an employee for tax purposes.
If TRA finds out that your full-time GM is categorized as an independent contractor and you’re giving him/her equity so you can avoid paying salaries, you’re going to be in big trouble.
As the government of Tanzania takes action in line with the World Bank’s April 2017 Economic Update to unlock the potential of the private sector and leverage the sector’s resources into key investments, a good start-up lawyer can ultimately help you start your investment or business activity on the right legal footing by avoiding potential legal pitfalls and disagreements that you could run into, and reducing the danger of court action and other risks, and eventually saving you time, more costly legal fees and the enormous headaches in future.