The creation of a startup

“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:

• Name and address of persons executing said articles before a Notary Public (the “Subscribers”).
• Name of the corporation.
• Description of the activity it will carry out, which may be a generic description;
• Authorized capital, number and nominal value of the shares.
• Classes of shares, number of each class, special rights of each class.
• Number of shares of each Subscriber.
• Registered office of the corporation and resident agent.
• Duration of the corporation (which can be perpetual).
• Number of directors (not less than three).

Shares

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.

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.

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.

Relationships between 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:

• Limitation of selling or disposing of the shares of the corporation for a determined period of time.
• A right of first refusal.
• The rules under which the business must be conducted.
• The types of shareholders who will have the right to choose the Board of Directors.
• The qualifications that a director must have to be approved.
• The obligation to contribute capital if necessary.

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.