Legal Considerations for Launching a Start-up in Canada
Launching a tech start-up in Canada involves more than just developing innovative technology and securing investment. To ensure a smooth journey from inception to exit, it is crucial to address various legal aspects early on. Trusted legal advisors who understand the tech industry can be invaluable. This guide outlines the essential legal components for tech start-ups, covering capital structure, shareholder agreements, stock options, intellectual property, data privacy, employment, and tax considerations.
Capital Structure
Founders and early employees typically receive common shares, sometimes with different rights (e.g., voting and non-voting). Setting the company up with simpler structures is usually preferred by institutional investors. Early stage founder and contributor equity often has vesting terms attached to it in order to ensure that early stage individuals are incentivized to continue with the company for a longer term.
Early fundraising is often completed through the use of convertible instruments such as convertible notes and/or simple agreements for future equity (SAFEs).
Grants and debt sourced from various sources, including government, are often used to supplement more traditional fundraising throughout.
Stock options are typically used to provide equity incentives for employees, advisors, officers and directors. Use of options requires adoption of a stock option plan, the terms of which should be kept within industry norms in order to prevent questions from later investors, acquirers or even the option recipients themselves. While equity incentives are attractive, excessive allocation can dilute founder ownership, which can be a hurdle for attracting institutional investors at later stages.
Preferred shares are often issued during priced financing rounds (e.g. Seed or Series A). Over the past decade or more, the terms for preferred shares used in venture capital financings in Canada and the US have become more standardized than they were previously. There are publicly available resources that can be used to compare proposed terms of any specific financing against widely accepted model documents.
Accurate documentation of share issuances and stock options is crucial to avoid disputes over ownership and vesting later on.
Shareholders Agreements
Shareholders agreements define the rights and obligations of shareholders, outline decision-making processes, board appointments, and provide solutions for potential disputes. These agreements should be in place early, even with few shareholders, and often must be renegotiated when investors come on board. Early-stage agreements include board approval rights, governance provisions, rights of first refusal, co-sale, and drag-along rights. Later investors may require the addition of additional investor friendly terms such as pre-emptive rights, information rights and registration rights.
Intellectual Property
Intellectual property (IP) often represents the core value of a tech start-up. Protecting IP through patents, trade secrets, copyrights, and trademarks is essential. Legal steps to secure these rights should be taken early, with agreements in place to protect company ownership of IP developed by founders, advisors, employees and contractors.
Data Privacy
Handling personal information responsibly is critical, especially in the digital economy. Data and personal information privacy is a complex and rapidly evolving area. Federally, Canada has a Personal Information Protection and Electronic Documents Act (PIPEDA), with additional requirements in Alberta, British Columbia, and Quebec. Non-Canadian jurisdictions may have similar laws that start-ups must comply with if they wish to offer products or services, store or process information or retain personal in those jurisdictions. Most jurisdictions, including Canada, also have anti-spam laws that start-up companies need to take into consideration in connection with their marketing and business development efforts.
Employment
Hiring the right team is crucial for growth. Employment agreements should include clauses to protect IP and address termination, non-solicitation, and, where appropriate, non-competition. These agreements can significantly impact financial obligations in the event of employee termination. Non-competition clauses must be carefully drafted to be enforceable and are not permitted in all jurisdictions. Location of work has recently started receiving more focus than in prior years. Employers have to understand where their employees work and, if employees are located in a different Province or foreign jurisdiction, understand the employment, tax and, potentially, immigration laws of such other jurisdictions.
Tax Considerations
Canadian tech start-ups benefit from favorable tax rates for Canadian-controlled private corporations (CCPCs) and can access scientific research and experimental development (SRED) tax credits. Maintaining CCPC status can optimize tax benefits, and start-ups should work closely with legal and tax advisors to ensure compliance with relevant tax laws and maximize incentives.
Conclusion
Navigating the legal landscape is crucial for the success of a tech start-up in Canada. Addressing capital structure, shareholder agreements, equity incentives, intellectual property, data privacy, employment, and tax considerations early on can pave the way for growth and attract investment. For personalized advice, consult with legal experts familiar with the tech industry.
If you have any questions about launching your tech start-up, our team at LaBarge Weinstein LLP is here to assist you. Feel free to contact us at info@lwlaw.com.
The foregoing is not legal advice. This article is intended as high level information that might be helpful to start-up founders and others considering involvement in a technology start-up in Canada and is not exhaustive in terms of the topics discussed or other legal considerations you should consider if starting a company in Canada. You are encouraged to seek legal advice specific to your circumstances, either with LaBarge Weinstein LLP or another qualified lawyer, before launching a new enterprise. Good luck!
