English 
Español How to protect my trademarks and ideas?
You are undertaking a project for a new business, a startup. You already have the financial/commercial side well thought-out, and have commissioned a designer to sketch a logo and design a corporate identity under the brand you have decided to use. You buy stationery, signs, business cards, among others. You commence the required process to obtain a notice of operation (Aviso de Operación) at the Ministry of Commerce and Industries and, at that moment, you realize that there is not one, but several businesses whose names are identical or confusingly similar to yours.
How did this happen?
To answer this question, we must first understand what a trademark is and what is its purpose. A trademark is a distinctive sign or set of signs (below we will explain what signs can constitute trademarks) that allows us to differentiate the products, services and trade name of one company from those of another.
The main feature of a trademark is its distinctive character, that is, it must be capable of distinguishing a product and/or service from others that already exist, in order for a consumer to identify, distinguish and differentiate said product and/or service from an existing one that is identical or similar in nature.
What type of signs can constitute trademarks? The applicable Panamanian law, Law 61 of October 2012, dictates that trademarks may consist of: words or a combination of words; images, figures, symbols and graphics; letters, numbers and combinations; three-dimensional shapes; colors in their different combinations; sounds; smells or tastes; or any combination of any of the previously mentioned elements.
So, based on the above, what are the different types of trademarks?
- Fanciful Marks: Those that provide the greatest distinctive strength, since they are distinctive words or signs that did not previously exist and were conceived / created for the purpose of distinguishing a specific product or service, such as “Adidas” or “Starbucks”.
- Arbitrary Marks: Those that are nothing more than brands made up of words with a well-known meaning, but the key element is that said meaning has nothing to do with the nature of the product or service they seek to identify, such as “Dove” for soaps and shampoos or “Apple” for computers. These names have a common meaning that is different from the products they represent.
- Suggestive Marks: Those which, as its name indicates, suggest the nature of the product or service or some of its characteristics, without directly describing it. For example, “Netflix” qualifies as a suggestive mark, since the word “net” suggests the use of the internet and the word “flix” is a shortened version of “flicks”, which is a colloquial way of saying “movies”.
- Descriptive Marks: Refers to words or sets of words that identify the characteristics or elements that make up a product or service and serve to describe that product. Examples of descriptive marks are “General Electric” for an electricity company and “Telefónica” for a mobile communications company.
- Generic Marks: Those that, because of their constant use, are merely the common name used to identify a product or service, such as “Kleenex”.
Before investing in the corporate image of a business, an entrepreneur or startup founder must verify the existence of identical or similar marks, to the extent that those similar marks could cause confusion. This is accomplished by carrying out a search or verification of trademarks that are in the process of being registered or have been registered with the General Directorate for Registration of Industrial Property (DIGERPI, for its name in Spanish), and in the Panama Emprende system, since, with regards to intellectual property, Panama recognizes a right over a trademark to those persons who first used the trademark within Panama for commercial purposes. This verification can be carried out electronically, through queries in DIGERPI’s database, or in writing, by submitting a search request with said entity.
In any case, consulting with an intellectual property lawyer is advisable, so as to properly interpret the results of a trademark search and/or provide advice on the procedure to register a trademark.
With regard to ideas, we note that a single idea is not protected intellectual property. Under the prism of copyright, the formal expression of ideas is protected. This means that the ideas must have been affixed or embodied in some material mean, such as a book, a canvas, an audiovisual work, an architectural plan, a poem or a song, to enjoy copyright protection.
Finally, the main advice before investing in the name and image of a new business, is to consult the various sources available with respect to trademark and notice of operations (Aviso de Operación), and seek legal advice from an experienced attorney in the field to avoid losing what was invested in promotional materials, creating an image, time and, in the worst case, being involved in a trademark dispute. We are at your service for any queries you may have on these issues.
For more information on these topics, please contact:
Allen Candanedo
MORGAN & MORGAN
Tel: 265-7777
Email: [email protected]
- Published in 2020, Allen Candanedo, startups
Startup Financing
A company’s need for substantial amounts of capital is intensified when looking to grow quickly, or develop an innovative product that will disrupt the market in a meaningful way. This is true to any company, and is especially true to innovative and disruptive startups, which aim at creating new markets, revolutionizing existing ones and prevailing over traditional market participants. To be disruptors, a startups’ product may need to go through testing, the startup may need hire experts in a particular field to assist in the development of a product, or invest heavily to gain scale in the short run and be competitive in a specific market. Thus, raising capital is, without a doubt, a key element in the life of a startup.
Initially, when founders are jumpstarting the company, they will have no other option but to use their own funds. However, as the business grows, and expenses pile up, the founders will need to turn to other methods of financing.
Two mechanisms by which startups may raise capital are (i) equity financing, whereby shares of the company are sold; or (ii) debt financing, in which the company may be required to put its assets as collateral to secure the debt. The latter may not be a viable option for a seed stage startup given that it may not have any assets, or the assets that it has are not an adequate guarantee for the loan. Consequently, convertible debt (which we shall discuss in a subsequent article) or equity financing are typically the most viable routes that startup founders take when looking to finance the operations of the startup. In this new Startup Series’ article, we will summarize the particularities of startup fundraising, the participants, and the terms that a founder should be paying attention to when negotiating with investors in a financing round or series.
The Players:
After founders have exhausted the seed capital, and require additional funding to keep financing the operations of their company, they will likely look for investments from close friends and relatives. At that moment, funding rounds involving friends and family, which will usually be informal compared to later rounds, will come into play. Because there is a certain level of trust between the investors and founders, the terms of the investment in a friends and family funding round will potentially be much more favorable to the founders, and investors will most likely not ask for special rights and protections such as voting rights over major decisions (or voting rights in general), board seats, or to be involved or actively participate in the management and operation of the company. However, founders must be sure to document every investment from friends and family, and have in writing all rights that are being granted to such investors.
In addition, ideally there will be:
i. A subscription agreement in which, among other things, the startup agrees to issue the shares and the investor agrees to transfer the money; and
ii. An adhesion to the shareholders’ agreement in order for both the investors and the founders to be clear on what are the rules of the game.
Nonetheless, there are certain rights that, due to their long term implications, founders should pay special attention to when thinking about granting them to friends and family investors, such as anti-dilution rights or the right to block subsequent rounds of financing, which might destroy the attractiveness of the startup from an angel investor or a venture capital investor’s perspective. Consulting a lawyer, even at these early stages, would be advisable so that founders may understand the reach of these provisions and will help save time and money down the road.
Next up, are the so-called “angel investors”. These are high net-worth individuals that will invest much more money into the startup than friends and family, will contribute their expertise, and will, occasionally, serve as mentors to the founders. Consequently, angel investors will likely require a certain level of control over management, and will ask for special approval rights over at least certain major decisions of the company, such as the sale of the business or a substantial part of its assets to a third party, or an exit to capital markets (an initial public offering or “IPO”). Although some angel investors may not be very sophisticated, they will often have legal counsel involved to assist them in negotiating better terms in a subscription agreement, or even bargain for convertible notes. Similarly, the founders must make sure to have a lawyer looking out for their best interest during negotiations with an angel investor.
Finally, the venture capital firm or “VC Firm” is where startups get the biggest investments from (if they get to that stage). VC Firms are highly sophisticated and will negotiate intensively to get the best deal possible from their perspective. They will often require the startup and past investors to agree to certain terms in exchange for their investment. For example, a VC Firms will often negotiate for drag-along clauses in which other shareholders of the startup will be required to vote in favor of resolutions that a majority of the shares voted for. This is designed to ensure that minority shareholders will not be able to veto acts that the majority of the shareholders are in favor of.
Typically, these key terms, and others which we discuss below, are negotiated through a term sheet, which will serve as a basis to be used to draft the documents that will be signed in order to formalize the VC Firms’ investment.
The Terms:
Every time a startup founder decides to go through a financing round, he/she must be prepared to negotiate the economic and control aspects contained in the securities or financial instruments being offered. Thus, below we list the most important terms that we consider should be taken into account when a startup is raising capital, regardless of whether it is friends and family, an angel investor or a VC Firm.
1. Investment Type
A founder must decide what securities or financial instruments he or she will give in return for the investment. The investment may be, for example, in exchange for preferred stock with certain liquidation preferences (which we will discuss later); or convertible notes, which act as debt that is convertible into a class of shares when and if a certain condition is fulfilled.
The type of investment is relevant, because it will affect the amount of money that a founder will receive when the company goes through a new round of financing or the company is sold, or taken public through an IPO.
2. Valuation
Valuation refers to the value of the startup before (“pre-money”) and after (“post-money”) the investment. This is relevant because it will determine the percentage of the company the founders are selling, and how much they are diluting their participation, after finalizing an equity financing round.
For example, if during a seed series financing round, an investor puts US$ 500,000.00 into a startup with a US$ 2,000,000.00 post-money valuation, that means that the founder is selling 25% of his/her company in exchange for the investment. To determine the valuation of a startup, both the intrinsic data about the business (revenue, number of users, etc.) and the market value of the company (what investors are willing to pay for the company), must be taken into consideration.
NOTE: Take note that the “authorized capital”, as defined by Panamanian law, is not necessarily related to the valuation of the company, and that the nominal value of the shares will not necessarily define the price for which the shares of a Panamanian corporation may be sold.
3. Conversion Rights
Investors in funding rounds will require that they be issued shares which may be preferred and with a right to convert to common shares at any time. This may mean that if an investor is unhappy with the way a company is being run and decides to exercise it conversion rights, the investor will gain voting rights, which may lead to additional control over the company, and, in that case, there will be a risk that a founder is ousted a director or officer. To deter investors from converting their preferred shared into common shares before a liquidity event (usually defined as a sale of the company or a substantial part of its assets and/or stares) takes place, founders will typically offer liquidation preferences and participation rights (discussed in “4” and “5” below).
4. Liquidation Preferences
A liquidation preference is a very important and highly negotiated economic term in a funding round. The liquidation preference refers to the amount of money that the holder of a particular class or series of shares has the right to when and if the startup goes through a liquidity event.
Typically, an investor in a funding round will negotiate for a liquidation preference in the shares he/she is acquiring, in order to receive a certain amount of money per share if a liquidity event takes place. A common liquidation preference clause will say that the investor has the right to receive a per share amount of “X times the original purchase price of the shares, plus declared but unpaid dividends”. It is important to keep in mind that the liquidation preference, as its name indicates, gives the investor preference over the other classes or series of shares, thus, the investor that holds the liquidation preference gets paid before other classes or series of shares. A liquidation preference below “1x” would not make much sense, given that the investor would want to, at the least, recover his/her investment. However, investors may negotiate for a higher multiple (i.e. 1.5x, 2x, 3x and so on).
5. Participation Rights
In addition to a liquidation preference, startups may need to offer participation rights in order to make the investment more attractive (depending on the stage they are in and the successfulness of their business model). Participation rights are usually paired up with liquidation preferences, and the investor will have both if a liquidity event takes place.
During a liquidity event, a holder of shares with a liquidation preference and participation rights will have the right to receive payment for its shares before the holders of other classes or series of shares, and participate in the sale of the company as if its preferred shares had been converted into common shares. This combination of liquidation preference and participation rights is designed to ensure that the investor will at the least get back its investment (in the event that the company is sold for a price below the investor’s purchase price), or participate in the sale of the common shares and get a “premium” for assuming the risk at the time he/she made his/her investment (in the event the sale is over the investor’s purchase price).
Example A: Imagine that Investor A invests $20,000.00 for 20% of Startup S.A. in a seed series round (US$ 100,000.00 post-money valuation). In exchange for the investment, Investor A receives preferred shares with “1x” liquidation rights and participation rights. Thereafter, Startup S.A. is sold for US$ 1,000,000.00. If Investor A only had a liquidation preference, it will only get its initial US$ 20,000.00 investment back. On the other hand, if Investor A has a liquidation preference plus the right to participate in the sale, it will receive the initial US$ 20,000.00 investment back, and the participation rights will entitle Investor A to an additional US$200,000.00 (20% of US$1,000,000.00), as if the preferred shares had been converted.
If the situation is the opposite (Startup S.A. is sold for less than US$ 100,000.00), a liquidation preference guarantees that the investor will at least get back its initial investment.
Keep in mind that, as mention in section “3” above, investors will negotiate for preferred shares with the right to convert to common shares. Liquidation rights deter the conversion of the shares, because if the investor converts, then it loses its preference, and will only be able to participate in the sale of the company. The risk is that the company sells for a lower price than the investor’s purchase price and the investor loses its investment.
6. Composition of the Board of Directors
As one of the most important control aspects of a negotiation, an investor in a funding round will typically require the right to appoint at least one director to the board of directors in exchange for its investment. This guarantees that the investor will be represented in the board of directors and that the investor will be able to vote in board meetings, thus have control over the decision-making of the business.
7. Protective Provisions
Investors will negotiate for veto powers over certain major decisions of the company. Friends and family, and angel investors will seldom negotiate for veto powers. VC Firms on the other side, will require veto powers over, for example, mergers/change of control, incurring debt for over a certain amount, declaring dividends, and increases or decreases of authorized capital of the company, among others.
Founders will need to decide what type of major decisions they want to give investors control over. The important aspect here is that founders make sure that the same protective provisions are granted to investors of the various financing rounds. If different classes have different veto powers over major decisions, making decisions will be difficult and time consuming.
8. Antidilution
This is a term that a founder must be clear when entering negotiations with a potential investor. Generally, antidilution clauses will determine which shareholders get diluted when a new financing round takes place, and how much those shareholders will be diluted. This is relevant because, if not well defined, a founder may lose control of his/her company by diluting too much of his/her percentage in the company.
Keep in mind that each business and its financial needs must be evaluated taking into account their particular situations (amounts being raised, number of investors and shareholders, among others), so as to determine what economic and control terms deserve the most attention. We are at your service for any queries you may have on these issues.
For more information on these topics, please contact:
| Pablo Epifanio
MORGAN & MORGAN Tel: 265-7777 ext. 7783 Email: [email protected]
|
Miguel Arias M.
MORGAN & MORGAN Tel: 507-265-7777 ext. 7687 E-mail: [email protected]
|
Special Regimes relevant to Panamanian Startups
At the beginning of a startup’s life, the use of financial resources in the most efficient way is of vital importance. It is for this reason that the incentives that a country can provide to an entrepreneur and his newly formed company can potentially determine how and how much that company will grow.
In previous articles in this Startup Series, we summarized the advantages of incorporating a startup under Panamanian law, and briefly mentioned some of the incentives that exist in our legislation. In this new edition, we will expand on some of the applicable special regimes, so that founders can be generally aware of the most relevant incentives for his or her field.
Panama is the ideal jurisdiction to develop all kinds of entrepreneurial initiatives due to its wide array of special commercial regimes and its state-of-the-art logistics facilities. From Panama, activities that have effects outside of Panama, such as the distribution of products at the regional level or assembly of products destined to be exported, can be carried out. These activities have specific tax rules, which are covered by special trade and fiscal regimes. With this in mind, and considering that a startup depends on exponential growth in a short period of time, understanding the different incentives and regimes available can boost the business from its early stages.
In addition to the tax advantages provided by the Principle of Territoriality, which we have already discussed, there are a number of special regimes in Panama that, although not expressly created for startups or entrepreneurial businesses, are designed in a manner that could be used to stimulate the economic activities in which the startup is involved. Undoubtedly, amongst the special regimes that could be applicable to startups are the incentives for companies dedicated to research and innovation in scientific, technological, humanistic and cultural fields that are located within the City of Knowledge Foundation complex.
- For innovative companies located within the City of Knowledge Technopark, there are important tax incentives such as: the exemption from import tax on the machines, equipment, furniture, vehicles, devices and supplies necessary for the development of said companies; exemption from the Tax on Transfers of Movable Personal Property and Services (“ITBMS”) on machinery, equipment, vehicles, devices and supplies that are acquired and necessary for the development of said companies; and exemption from any tax, duties, or encumbrance imposed on the remittance of money abroad when such remittance or transfer of funds is carried out for some purpose of the companies.
There are also special regimes that provide incentives to industrial manufacturing, agro-industrial, and marine resource transformation companies. Companies engaged in these activities may obtain an Industrial Development Certificate by filing a request to the Ministry of Commerce and Industries in which, among other things, they must describe the activity of the company and the product or products that are currently being manufactured. The certificate confers benefits to its holders, such as the reimbursement of 35% of all disbursements made for research and development of new and improved processes, product features or the creation of new products. Additionally, the losses suffered by the companies holding the aforementioned certificate during a fiscal period will be deductible throughout the following five fiscal periods, at the rate of 20% per year. It is important to mention that companies will not be able to take advantage of the benefits conferred by this law if, among other things, they already enjoy other tax benefits, or if they are located in special zones, free zones, fuel free zones or any other zones that are established in the future by special laws.
Other important incentives that deserve mention are those afforded to companies established within the Panama-Pacific Area, which will enjoy exemption from import tax on all types of merchandise, equipment, service, products and other goods introduced to the Panama-Pacific Area, exemption from ITBMS, exemption from export and re-export tax, among others. Companies established within Free Zones, tourism companies and investors in tourism companies; and headquarters of multinational companies are also afforded with exemptions and tax benefits that a startup could take advantage of, if applicable. Lastly, Panamanian legislation grants incentives to multinational companies that establish their base of operations for Latin America in Panama (these head offices are known as the Multinational Headquarters or “SEM” for its name in Spanish), such as exemptions from income tax for services provided to entities domiciled abroad that do not generate taxable income in Panama and exemption from sales tax for services rendered to entities domiciled abroad that do not generate taxable income in Panama, among others (for more information on the SEM special regime, click here).
It is important to highlight that, as a commitment to reinforcing international tax transparency, Panama has been part of the Base Erosion and Profit Shifting (BEPS) initiative since 2016, and that regimes such as SEM and Panama-Pacific comply with such substantive rules aimed at ensuring consistency, transparency and belonging in all its activities.
Equally relevant for startups, are incentives for micro, small and medium-sized enterprises (MSMEs). The law under which these incentives are granted defines MSMEs as follows:
- Micro-enterprise: One that generates gross revenue or annual turnover up to the sum of US$ 150,000.00.
- Small-sized enterprise: One that generates gross revenue or annual turnover between $ 150,000.01 and US $ 1,000,000.00.
- Medium-sized enterprise: One that generates gross revenue or annual turnover between US $ 1,000,000.01 and US $ 2,500,000.00.
Startups wishing to benefit from this regime must submit a request to be listed in the Business Registry of the Authority for Micro, Small and Medium-sized Enterprises (AMPYME). Such request must provide, among other things, a suitable income statement or letter from an accountant certifying the company’s annual turnover (recently constituted companies are exempted from this requirement). Thereafter, the MSME must register with the General Revenue Office (DGI, for its name in Spanish) for its special regime to be incorporated into its taxpayer profile. Once the company is registered, it will be exempt from paying income tax for the first 2 fiscal years, counted from the date in which the MSME was registered in AMPYME. Note that, as a temporary measure aimed at mitigating the effects of the COVID-19 crisis, the income tax exemption afforded to MSMEs has been extended to cover the first 3 fiscal years, counted from the date in which the MSME was registered in AMPYME. In addition, such enterprises may participate in AMPYME’s Business Development Program, gain access to the Seed Capital Fund Competitive Program and the PROFIPYME Financing Program, the Microcredit Financing Fund for Small and Medium-sized enterprises, and will be given priority in public bids in which there is a tie between two companies.
All that said, it is clear that Panama offers a significant number of special regimes and tax benefits. These regimes may well be taken advantage of by a founder who wishes to establish his or her company in Panama and grow his or her startup in a short period of time. Given the need for a startup to achieve scale quickly, having the government’s support and incentives is beneficial and could be a component that a potential investor takes into account when investing in a startup. Finally, each business must be evaluated so as to determine whether the incentives mentioned herein are applicable. We are at your service for any queries you may have on these issues.
For more information on these topics, please contact:
| Tax-related inquiries:
Amanda Barraza |
Angelica Ortiz |
| Corporate-related inquiries:
Kharla Aizpurúa O. |
Miguel Arias M. |
Feasibility of Organizing a Startup as Limited Liability Entrepreneurship Company
On July 22, 2020, the National Assembly approved, after a third debate, Draft Law No. 83 (the “Draft Law”), which regulates limited liability entrepreneurship companies (the “LLECs”) in Panama, and is now awaiting the signature (or veto) of the President of the Republic.
The Draft Law’s object is to “streamline and simplify constitution procedures” of these special legal entities, so as to reduce the costs and the bureaucracy that usually prevail in the path towards entrepreneurship, as well as to “promote job creation through a new form of business.” It is clear that this Draft Law is a great step towards the formalization of many businesses, furthermore, it is an additional incentive for Panamanians to start a business and contribute to the development of the local economy. However, it is necessary to evaluate whether this Draft Law, if signed by the President, will effectively contribute to the creation of an entrepreneurship “hub” in Panama, and if the entity is an attractive one for a startup.
As we have mentioned in the past, startups are characterized by rapid and exponential growth, and require large capital injections in a short span of time in order to finance their operations, achieve the necessary scalability to penetrate international markets and become true disruptors. It is for this reason that, as a premise, we pose that startups, by nature, should not be considered analogous to a micro, small and medium enterprise (MSME), given that they that grow rapidly and require a lot of capital, unlike MSMEs that grow gradually for extended periods of time and capital injection will depend on their scale over time. Within the applicable regulations, startups should not be defined based on the same criteria used to define MSMEs, because this would be an inadequate definition of what a startup is and of its potential. We underscore then, that according to Article 25 of the Draft Law, LLECs have revenue limits based on the definitions of micro and small companies, and that, if a company generates gross revenues above those limits, it would lose its status as an LLEC. This is inconvenient for a startup given its exponential growth. If a startup quickly gains scalability, its gross revenues can be very high from the beginning, however, high gross revenues do not necessarily mean that a startup is turning a profit. Measuring the status of a startup based on its gross revenues (which is effectively treating a startup as if it were a MSME) gives a false perception that the company is not, in effect, a fast-growing company. In the recommendations that emerged from a 2016 study published by the Organization for Economic Co-operation and Development (“OECD”) and entitled “Startup Latin America: Building Innovative Future” (hereinafter the “OECD Study”), reference is made to, for example, countries like Chile and Mexico, leaders in the promotion of startups in Latin America, who opted to define a startup based on their performance (growth potential), innovative potential, global target market and capacity to meet the specific needs of a country or region.
In its Article 5, the Draft Law stipulates that LLECs may only be composed of members who are natural persons, effectively limiting the type of person that can invest in these companies. Although it is true that at the beginning of a startup’s life, the founders will likely be natural persons, it is possible that a startup would want to invite a capitalist partner to join the company (often, in addition to providing capital, these partners have vast experience and can serve as mentors or advisors). It is possible that these potential capitalist partners will wish to invest, for various reasons, through their own legal entities; so, this limitation on who can be members must be taken into account when considering the type of legal entity under which the startup will be organized. In addition, since private companies often have the ability to contribute seed capital to a startup, encouraging the private sector to devote part of its resources to invest in startups and encourage local entrepreneurial culture is key to creating a robust startup industry. On this, the aforementioned OECD Study commented that:
“[…] Commercial banks, development banks and investment funds could boost the region’s entrepreneurial ecosystems. The region still needs to channel more private capital towards productive investment, but for this to happen, countries will need to reform legislation to foster private investment, while investors will need to change their mindsets.”
Additionally, Article 7 dictates that “one to five persons […] residents of the Republic of Panama” may constitute an LLEC. From this, it is not clear whether only the persons who constitute the LLEC are required to be residents of Panama, or whether the LLECs are reserved for Panamanian residents, meaning that there can be no foreign members in LLECs. If the latter is true, then the effort to attract foreign investors and entrepreneurs to Panama would be frustrated and would further reduce the pool of capitalist partners that may invest in LLECs. According to a 2019 Forbes’ publication, 50 of the 91 billion dollar startups in the United States of America, which have a combined value of US $ 248 billion, were founded by immigrants. Hence, if Panama seeks to become an entrepreneurship hub, closing its doors to foreign ventures that turn to other countries in the region due to the limitations imposed by the laws in their jurisdictions does not contribute towards achieving this goal.
An important aspect of a startup is that relationships between shareholders and investors are extremely complicated and ever-changing. Allowing an LLEC to be created without seeking advice of an attorney can be good from the point of view of streamlining the process, but for a startup it can result in future complications, in the event that there is friction between shareholders or investors. This is why a startup’s articles of incorporation must have clear rules on, for example, shareholder rights and sale restrictions. In the absence of these, the shareholders of a startup must execute a shareholders’ agreement, so that corporate governance rules, as well as any other aspects of the company that they wish to regulate (such as capital commitments and dilution of shareholding) are duly agreed upon. Under the Draft Law, LLECs may be constituted through the filing of a “standard statute,” a model of which will even be provided by the PanamaEmprende portal. An entrepreneur is rarely thinking about the legal consequences of incorporating a company or the rules under which that company will be governed. That’s why it is important to seek legal counsel to which the entrepreneur can explain his or her needs and concerns, so that the attorney may produce documents that meet those expectations and better manage the problems that may arise in the future.
Amongst the most common methods in which a startup raises capital to finance its operations is through the sale of its shares; so, the shareholding structure of a startup will undergo various changes throughout its life. Additionally, often the shares sold in different financing series have different rights and obligations from those owned by founding shareholders (such as preferential liquidation rights and conversion rights), which provides an additional incentive for an investor to contribute capital to the startup. Under the Draft Law, LLECs, which have a structure similar to that of limited liability companies (“LLCs”), must keep “all the information regarding changes to their structure or their administrators and/or members” up to date. Thus, information regarding the members is not private and transfers or sales of participating quotas must be recorded in the Public Registry; a process which may be cumbersome and would add an additional layer of complexity to financing rounds, a fundamental phase of any startup. Additionally, nothing in the Draft Law seems to indicate that LLECs can issue participating quotas of different classes, which means that in a financing round, only participating quotas with the same rights, obligations and restrictions as the rest of the partners could be offered to new investors (same situation as with SRLs). Encouraging private investment in startups is an essential component of the development of these businesses, and shares of different classes with, for example, preferred liquidation rights, are part of the allure of investing in a startup. The Draft Law significantly limits the chance to attract capital to the LLECs.
It is thus clear that the corporation, which is widely known to both Panamanian and foreign investors, is the preferred legal entity for a startup since it allows transfers to be made through private documents, the shareholding structure does not have to be recorded in the Public Registry and the issuance of shares of different classes is allowed.
Finally, the treatment that would be granted to LLECs in government bidding proceedings by way of Article 36 could be prone to abuse. Under said article, individuals or legal entities that participate in public bids for better value and include one or more LLECs in their proposals will enjoy “an additional score of 5%”. This preferential treatment may cause consortia to include LLECs in their bids just to get the benefit of the additional score, and not because SERL truly contributes something to the consortium. Likewise, it is not clear how this benefit is administered — that is, whether it applies to both price scoring and technical scoring, or only the latter. This confusion may result in legal challenges to bid proceedings, which would have a counterproductive effect.
It is worth mentioning that, in principle, a law that encourages entrepreneurship and the creation of companies in an easy, dynamic way and under a streamlined process is a good step in favor of the startup industry. In fact, the OECD Study mentions several of the components contained in the Draft Law as important components for the promotion of startups, such as the simplification of the incorporation procedure, the promotion of entrepreneurial culture and implementation of strategies aimed at improving entrepreneurial-related education. However, for Panama to become a true hub of innovation and startups, there are several other aspects to be considered, such as the promotion and facilitation of investment, removal of entry barriers to certain industries such as financial and retail, the introduction of new financing methods such as crowdfunding and the provision of instruments that expedite such forms of financing. We are at your service for any queries you may on have on these matters.
For more information, please contact:
| Inocencio Galindo MORGAN & MORGAN Tel: 265-7777 ext. 7734 Email: [email protected] |
Miguel Arias M. MORGAN & MORGAN Tel: 507-265-7777 ext. 7687 E-mail: [email protected] |
- Published in startups
The creation of a startup
An entrepreneur has a lot to consider when starting a new business. Who will be part of the team? Who will manage the company? How will decision-making be handled? Without a doubt, from the legal standpoint, among the first questions that an entrepreneur must ask him or herself is: What type of entity should I incorporate? Although this question may seem strictly legal, the type of entity that is chosen has important consequences for the administration of the startup and for the relations between the partners and/or shareholders, among other things.
Imagine two people (hereinafter, the “Entrepreneurs”) have been developing a business idea they believe to be marketable. The Entrepreneurs are willing to invest capital and effort to develop the idea, but they are unsure about how to structure the entity under which the business will be handled. To this end, the Entrepreneurs request the advice of a lawyer to advise them on such structure.
The lawyer explains to the Entrepreneurs the importance of organizing the company as a separate legal person, given that this way the company will have its own legal personality, separate and distinct for all its acts and contracts, from that of the Entrepreneurs. If, for example, the entrepreneurs start their business without a duly organized corporation, there are circumstances under which it may be considered that they have constituted a “de facto” partnership, which would mean that the Entrepreneurs are jointly and severally for the contracts that the partnership enters into, as well as any other obligations assumed by the partnership. That is, the Entrepreneurs could end up being personally liable for the debts incurred by the partnership, without any type of limit. The Entrepreneurs explain to the lawyer that, given the potential for rapid growth that they expect their startup will have, they wish to establish a company in which they can designate the everyday decision-making power to a limited number of people, however, the Entrepreneurs, as shareholders, want to maintain control over certain major decisions. In addition, they do not rule out that there might be some interest on the part of investors, who will want to finance the Startup’s operations through the purchase of shares in the company, as long as there is a difference between the shareholding of these new investors, and the Entrepreneurs, who would be the original founders and shareholders.
The ideal type of entity for this startup would be a Corporation (Sociedad Anónima) (hereinafter, “Startup, S.A.”). The incorporation process is simple; for the corporation to acquire its own legal personality, two or more persons, regardless of their nationality or domicile, must execute the Articles of Incorporation before a local Notary Public and record it in the Public Registry.
Hence, below are some of the characteristics that Startup, S.A. will encompass:
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“Startup, S.A.” |
Articles of Incorporation |
The Articles of Incorporation regulate the relationship between the shareholders of the corporation, and commonly establish the parameters under which, for example, the members of the board of directors of the corporation will be chosen, the restrictions on the transfer or sale of shares, the powers of the shareholders’ assembly and board of directors, among others. To incorporate Startup, S.A., its Articles of Incorporation must contain:
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Shares |
Startup, S.A.’s authorized capital must be made up of shares (represented in share certificates).
On this particular case, since, for the moment, there are only two shareholders, it is not necessary to issue more than one class of shares (unless the Entrepreneurs consider this is warranted). Once the value and number of shares that will be issued has been determined, the Entrepreneurs will invest their capital and Startup, S.A. will issue share certificates and annotate such issuance in the corporation’s share registry. For purposes of a startup, it is important that the Entrepreneurs keep a capitalization table (“Cap Table”) in which a log of the share issuance is kept (including preferential shares with conversion rights, employee share options, and loans with rights to shares in the event of non-payment), to better understand what is the effect of capital infusions in funding series (such as dilution of the Entrepreneurs participation). Also note that capital contributions can be both in money and in services, as long as the service has a value equal to or greater than the shares that are being issued in exchange for said service. It is important to emphasize that the Articles of Incorporation can be modified by the shareholders if they so agree, therefore, what the Articles of Incorporation initially provide will not necessarily be so for the entire life of the corporation. By means of a shareholders’ meeting it is possible, for example, to increase the number of shares in the corporation, and even authorize different classes of shares with different designations, preferences, privileges, voting rights, restrictions or requirements, all of which will be relevant when investors start showing up. The issuance of different types of shares is a common methodology for raising capital. Thus, specific classes of shares are issued in each of the financing rounds, and the investor receives certain benefits and special incentives that motivate the investor to participate in the particular financing round. In addition, it is a common way for founders to retain control of the corporation. |
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Control and administration of the corporation |
The Board of Directors of a corporation is the entity responsible for the administration of the business. The Directors’ decisions must be taken together and adopted by majority in order to be valid. The Articles of Incorporation will generally provide for the election of the directors, the period during which they will hold the position and how will they be chosen. Directors have absolute power over the corporation, as long as said power does not conflict with the rights of the shareholders, which, according to Panama’s Commercial Code, are the “supreme power” of the corporation. By law, there are certain acts over which only the shareholders have control, such as: modifying the Articles of Incorporation, deciding on the merger of the corporation with another, among others. However, the Articles of Incorporation may grant additional powers to the shareholders. Having said all this, for Startup , SA, the Board Directors shall have the power to make decisions on behalf of the corporation, and will also determine the policies, guidelines and directives under which corporation will be governed, and will delegated their implementation to a “general manager”, who will manage the day to day operations of the corporation. To ensure that control over the corporation is maintained, the initial directors of the corporation will be the two Entrepreneurs, plus one additional person, given that by law it must have at least three directors. Also note that it is neither necessary nor mandatory for the directors of the corporation to also be shareholders. Once new investors are allowed into the corporation, these investors may require that they be issued shares with voting rights and be given a seat on the board of directors, in order to have control and oversight of their investment. |
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Sales of Shares |
The entrepreneurs can sell their shares if they so desire, always subject to the stipulations of the Articles of Incorporation. It is common to establish in the Articles of Incorporation that the shareholders of a corporation must offer their shares to existing shareholders before offering them to third parties (this is known as a right of first refusal), however it is not a requirement. If there is no restriction, the shares of a corporation can be freely traded through private documents, without the need to register the transfer in the Public Registry. If, for example, the Articles of Incorporation contain a restriction on the transfer of shares (such as the right of first refusal, among others), such procedure must be followed to sell the shares. If there is no such right, shareholders are free to sell or dispose of their shares as they wish, without consent of other shareholders or the Board. In the case of Startup, S.A., it is preferable not to include restrictions on the transfer or sale of shares, since one of the ways in which the corporation will be raising capital will be through the sale of shares. The terms and conditions under which new shares and new classes of shares will be issued may be determined at the time of their issuance. |
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Relationships between Shareholders |
Having said all of the above, nothing prevents the shareholders of a corporation from signing a shareholders’ agreement so as to expand on the rules governing the relationships of the shareholders.
In this case, the Entrepreneurs would sign a shareholders’ agreement, to which all future shareholders of the same class of shares as the Entrepreneurs would be obliged to adhere to. This agreement would establish, among others, things such as:
Additionally, when facing a capital injection by a new investor, the shares that are sold to the investor or investors, may include special rights and obligations, depending on what is negotiated. In these events, the most important aspects to negotiate are economics and control, given that the Entrepreneurs will want to keep control of Startup, S.A. and avoid dilution of their economic participation; and the new investors will want to have some control over their investment and make sure it provides a return at some point in the future. Capital raising issues will be covered in other articles in the Startup Series. |
After incorporation of Startup, S.A., the Entrepreneurs will need to take certain steps in order to operate and protect their business, and make sure that it is attractive for future third party investments:
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For more information on these matters, please contact:
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Kharla Aizpurúa O. |
Miguel Arias M. |
- Published in startups
Why incorporate your startup in Panama?
In the corporate world, there is a novel type of enterprise labeled “startup,” which is known for its rapid growth, partly, because of the fact that it is highly related to the general use of information and communications technologies (ICTs) and the latest business trends. Given the rapid growth and scale that characterizes a successful startup, one of the initial considerations when launching a business of this type, and one that will significantly impact the way the company is managed, and the relationships with and between shareholders and investors, is the law under which the company is organized.
With this in mind, and as an introduction to a series of articles we will be publishing focusing on startups, we briefly summarize the reasons why organizing a startup under Panamanian law could pose benefits for its creation, capitalization, hiring of personnel, operations, financing, and eventual sale or public offering.
Before elaborating on the benefits of submitting a business to Panamanian law, it should be noted that according to the World Bank’s Doing Business 2020[1] report, Panama obtained a score of 92 out of 100 regarding the ease of starting a business, and one of 80 out of 100 on the ease of obtaining credit. The average score for Latin America and the Caribbean was 79 and 52, respectively, which positions Panama as a leading country in the region. This, coupled with the fact that its legal currency is the United States of America dollar, and the interconnectivity that it offers to the region thanks to its geographical location, positions Panama amongst the best Latin American countries to start a business in.
Once an entrepreneur has a concrete idea that he or she wants to develop and commercialize, the first step he or she must take when entering the world of startups is to incorporate its business. The main advantage of starting a business by way of a corporation is the fact that the company will have its own legal personality, separate and distinct, for all its acts and contracts, from that of its founder and shareholders.[2] It would be ill-advised for a founder to carry out her commercial activities in a personal capacity due to the implicit risks of each business, so, having a corporate structure that limits the liability of the shareholders is paramount. Undoubtedly, the most common legal vehicle in Panama is the corporation, which is regulated by Law No. 32 of 26 February 1927 (the “Corporations Law”), and details the requirements for the constitution, shareholding structure and administrative bodies, among others, of the corporation. The Corporations Law dictates that to incorporate a company, two or more persons of any nationality and domicile must execute the Articles of Incorporation before a local Notary Public; once the Articles of Incorporation have been recorded as a Public Deed and registered in the Public Registry, the corporation effectively acquires legal personality.[3] This incorporation process is relatively simple and can take between 4 – 6 business days. However, it is important to engage legal counsel, who, in compliance with the Corporations Law and the regulations over resident agents, will act as resident agent and carry out the due diligence prerequisites needed for the resident agent to act as such, and will ensure that the Articles of Incorporation contain everything that the Corporations Law requires and that the process be carried out correctly so that the law will produce all the effects and meet all the practical needs of the respective business.
It is also important to mention that there are other types of commercial entities in Panama, such as limited liability companies (“LLCs”), for example. However, for purposes of a startup, corporations are the preferred legal entity because of their flexibility in the offering of shares to the public, among other reasons. One of the most common ways in which a startup raises capital to finance its operations is through the sale of shares to investors (generally “angel investors” or “venture capital investors” will request shares in exchange for their investment). If the startup is organized as an LLC, the company’s articles of incorporation, which is a document that is recorded in the Public Registry, must be modified every time participating quotas are sold to an investor, therefore, each of these sales will need to be recorded in the Public Registry.[4] Furthermore, the members that have paid for an LLC’s participation quotas in full will have the right to vote in the deliberations of said LLC, [5] which means that LLCs may not issue participation quotas that consist, exclusively, of economic rights. Conversely, a corporation may issue or transfer its shares through private documents, and such shares may be of different classes and grant different economic and voting rights (for example, special voting rights for the class of shares issued to the startup’s founders). The latter is relevant when it comes to public offerings of shares, or even private placements targeting sophisticated investors.
Regarding taxation, Panama’s fiscal regime is governed in accordance to the Territoriality Principle which establishes that a natural or legal person is subject to the payment of income taxes only on income that is generated within Panama, that is, through operations or activities carried out within the territory.[6] Our Tax Code establishes that activities such as directing operations that are being carried outside the territory, from an office in Panama, and distributing dividends that come from income not produced within the territory, for example, do not give rise to taxable income in Panama. This means that a startup organized under Panamanian law would only pay taxes on the income that is generated by its Panamanian operations, which can represent significant savings for a company in its seed stage.
Additionally, Panama provides for series of tax incentives that could be applicable to a startup depending on its business. There are laws that exempt from paying certain taxes and grant tax credits, among other incentives, to industrial manufacturing, agro-industrial and marine resource re-purposing companies[7]; companies located within the Fundación Ciudad del Saber complex that are dedicated to research and innovation in scientific, technological, humanistic and cultural fields; [8] companies established within the Panamá-Pacifico Area;[9] companies established within Free Zones;[10] tourism companies and investors in such tourism companies;[11] multinational companies’ headquarters;[12] and micro, small and medium-sized enterprises,[13] among others. Our second article will address these in detail, so stay posted for future articles of this series.
For those startups that need to import talent from abroad, there are also immigration incentives in place, such as temporary resident permits for trusted personnel, executives, experts and / or technicians, among others. This could be advantageous for startups interested in having advisors or mentors in key positions of their startups to guide the founder in financing rounds, for example.
Having said all this, it is important that each business idea be evaluated considering the provisions of the law so that decisions are made based on the particulars of each case and the advantages that may be offered by Panamanian legislation are harnessed at their highest level. We are at your service for any questions you may have on these issues.
For more information on these matters, please contact:
| Kharla Aizpurúa O. MORGAN & MORGAN Tel: 265-7777 ext. 7652 E-mail: [email protected] |
Miguel Arias M. MORGAN & MORGAN Tel: 507-265-7777 ext. 7687 E-mail: [email protected] |
[1] https://www.doingbusiness.org/content/dam/doingBusiness/country/p/panama/PAN.pdf
[2] Article 251, Commercial Code of the Republic of Panama.
[3] Article 1, Corporations Law
[4] See Law 4 of 9 January 2009.
[5] Article 3, Law 4 of 9 January 2009.
[6] Article 694, Tax Code of the Republic of Panama.
[7] Law No. 76 of 23 November 2009, as modified to this date.
[8] Law Decree No. 6 of 10 February 1998.
[9] Law 41 of 20 June 2004, as modified to this date.
[10] Law 32 of 5 April 2011.
[11] Law 80 of 8 November 2012.
[12] Law 47 of 24 August 2007, as modified to this date.
[13] Law 8 of 29 May 2000, as modified to this date.
- Published in startups
Panama: New Law on Protection of Personal Data
With the enactment of Law No. 81 on Protection of Personal Data, the Republic of Panama aims to establish the principles, rights, obligations and procedures that regulate the protection of personal data, also considering their interrelation with private life and other rights and fundamental freedoms of citizens, by natural or legal persons, public or private law, lucrative or not, that process personal data in the terms provided in the Law.
Storage or transfer of personal data:
The storage or transfer of personal data of a confidential, sensitive or restricted nature, outside the territory of Panama, by the company responsible for the storage of data or custody thereof, will be allowed, provided that the company and/or country of residence have standards of protection comparable to those of the Law or if the entity that transfers the data makes sure to adopt all the necessary steps so that it is protected. The following cases are excepted from the aforementioned requirements: (1) when the owner has granted its consent for the transfer; (2)when the transfer is necessary for the execution or enforcement of a contract by the interested party; (3) in cases of bank or money or stock exchange transfers; and (4) in case of information whose transmission is required by law or in compliance with international treaties ratified by Panama.
It establishes the obligation to develop procedures, protocols and processes for the management and transfer of data that includes the appropriate security methods.
Consent of the owner of personal data:
It is established that the processing of personal data can only take place as permitted in this Law, or with the consent of the owner of the data.
Definition of sensitive data:
Sensitive data refers to the private sphere of its owner or whose misuse could give rise to discrimination or entail a serious risk for him/her– for example, of racial origin, religious beliefs, union affiliation, political opinions, data related to the health, life, preference or sexual orientation, genetic data or biometric data, among others aimed at uniquely identifying a natural person.
Sensitive data can not be transferred except: (i) by explicit consent of the owner; (ii) when necessary to safeguard the owner’s life; (iii) when it is necessary for the recognition, exercise or defense of a right in a judicial proceeding; and (iv) when it has a historical, statistical or scientific purpose.
Rights of Access, Rectification, Cancellation, Opposition and Portability:
The rights of owners of personal data to exercise over those responsible for database processing are: (i) Access (to obtain the data and know the purpose and origin for which they were collected), (ii) Rectification (to access and request correction, modification or update), (iii) Cancellation (to request deletion of data), (iv) Opposition (refusal to provide or revoke its consent) and (v) Portability (right to obtain a copy of all personal data in a structure matter in certain circumstances).
Database custodians:
The database custodians that transfer personal data stored in a database to third parties must keep a record of them, which must be available to ANTAI, if requested to do so.
Personal Data Protection Council:
The Personal Data Protection Council is created, which has the following functions: to advise ANTAI in relation to the Law, recommend public policies, evaluate cases submitted for consultations and develop internal regulations and it is composed by:
- the Minister of the Ministry of Commerce and Industries;
- the General Administrator of the Authority for the Protection of Consumers and the Defense of Competition (ACODECO);
- the General Director of ANTAI;
- the Ombudsman, or its nominee;
- a representative of the National Council of Private Enterprises (CONEP);
- a representative of the National Bar Association;
- a representative of the Panama Banking Association;
- a representative of Electoral Tribunal; and
- a representative of the Chamber of Commerce, Industry and Agriculture.
The National Government Innovation Authority will have the right to address the council as a technical advisor.
Compensation:
Duty to compensate for pecuniary and/or moral damages caused by the unlawful handling of personal data.
National Authority for Transparency and Access to Information (“ANTAI”):
Right to appeal against ANTAI in case of claims to any database storage operator to resolve differences in the exercise of the aforementioned rights. The competent body for the fulfillment of the obligations of this Law is ANTAI except in the case of estities regulated by special laws, in which case the claimant must first submit its claim to the competent regulatory authority. The ANTAI, through the Directorate established to consider the matter, is granted the powers to impose sanctions. The decision of the Directorate in the ANTAI established to consider these proceedings may be challenged through a reconsideration appeal. A subsequent appeal may be filed with the Director General of ANTAI.
The sanctions may be between US$1,000 and US$10,000, depending on the severity and recurrence and may be a written warning, citation before the ANTAI, fine, closure of the database registration or suspension and disqualification of the storage activity and/or treatment of personal data. There are minor infractions (for example: not sending the information required by ANTAI), serious infractions (for example: processing data without the owner’s consent) and very serious infractions (for example: the collection of personal data in a malicious way).
Validity
This law will take effect two (2) years after its promulgation.
- Published in 2019, 2020, expertise, Kharla Aizpurua, News, Publications, startups, startups_resources