Understanding Legal Structures for Startups: A Guide

By Ledisi Mark

May 10, 2023

Starting a startup can be an exciting yet challenging endeavor. One crucial aspect that entrepreneurs need to consider is the legal structure of their startup. Choosing the right legal structure is important as it determines how the startup will be governed, its liability, and its ability to raise capital.

This guide aims to provide startup founders in Nigeria with a comprehensive understanding of the different legal structures available and the steps they need to take to establish their startups. By understanding the legal landscape and requirements, entrepreneurs can make informed decisions that protect their interests and set their startups up for success.

What is a Startup?

Before delving into the legal structures, let’s first define what a startup is. A startup is a fast-scalable business that aims to provide goods or services to a target audience. It is typically founded by one or a group of entrepreneurs driven by the desire to create value and meet the needs of their target market.

In Nigeria, the formation of a startup is regulated by the Companies and Allied Matters Act, 2020. According to the Act, two or more persons can form and incorporate a company by complying with the requirements set forth. These requirements include being of legal age, having a lawful purpose for the startup, and not being declared of unsound mind by a court of law in Nigeria.

It is crucial for entrepreneurs to ensure that their proposed startup operates within the provisions of the law, including the Constitution of the Federal Republic of Nigeria, 1999 (as amended), and the Companies and Allied Matters Act, 2020.

Types of Startup Structures in Nigeria

Nigeria provides several business structure options for startups. Each structure has its own characteristics, advantages, and legal requirements. Understanding these structures is essential for entrepreneurs to make an informed decision based on their startup goals and circumstances. Let’s explore the different types of startup structures in Nigeria:

Private Companies Limited by shares
Public Companies Limited by shares
Unlimited Liability Company
Company limited by Guarantee/Incorporated Trustee

1. Private Companies Limited by Shares

A private company limited by shares is described within its Memorandum and Articles of Association as a private company. Its membership is limited to a maximum of 50 individuals, excluding those employed by the company. Private companies can sue and be sued in their name after successful registration and incorporation as prescribed by the Companies and Allied Matters Act, 2020.

Private limited liability companies are the most recognized and preferred type of business organization in Nigeria. They provide limited liability to shareholders, meaning their liability is limited to the extent of their investment in the company. This structure offers flexibility in decision-making and allows for easier ownership transfer.

2. Public Companies Limited by Shares

A public company limited by shares is incorporated under the Companies and Allied Matters Act, 2020 (CAMA) and registered with the Corporate Affairs Commission (CAC). The shares of a public company are traded publicly on a stock exchange, and the shareholders have limited liability, meaning they are only liable for the company’s debts up to the extent of their investment.

Public companies are required to have a minimum of two directors and a secretary. Unlike private companies, the membership of a public company is not restricted to a specific number of shareholders. Public companies enjoy advantages such as distinct legal personality, limited liability, corporate governance, and public disclosure requirements.

3. Unlimited Liability Company

An unlimited liability company is a hybrid company that can be incorporated with or without a share capital, but the legal liability of the members or shareholders within the company is not limited. In an unlimited liability company, members or shareholders share joint and non-limited responsibility to meet any insufficiency in the assets of the company.

Unlimited liability companies (ULTDs) consist of shareholders, partners, and founders who take full legal responsibility for all debts, liabilities, and profits incurred by the startup. An unlimited liability company can be either public or private. A major disadvantage of this structure is the unlimited liability imposed on members in the event of debt or winding up.

4. Company Limited by Guarantee/Incorporated Trustee

A company limited by guarantee, also known as an incorporated trustee, is a form of startup structure commonly used by nonprofit organizations. Its objective is to promote educational, sports, religious, cultural, or charitable purposes. It is not incorporated for the purpose of profit distribution to its members.

A company limited by guarantee is not registered with a share capital, and the liability of its members is limited to a predetermined amount, often set at N100,000 (one hundred thousand naira). This structure offers limited liability, legal recognition and protection, the ability to contract in its own name, and ownership of properties.

Trustees are appointed to hold and manage the assets of the organization, ensuring they are used for the intended purposes. This structure provides benefits such as limited liability, legal recognition, and the ability to own properties.

a. Sole Proprietorship

A sole proprietorship is a type of startup structure owned by a single individual who bears all the risks and liabilities of the startup. It is the simplest form of business to start and is often chosen by entrepreneurs who want full control over their operations.

In a sole proprietorship, the startup owner takes all the decisions and is responsible for all aspects of the startup. While employees can be hired, the owner retains sole decision-making authority and control over the shares of the organization. Sole proprietorships are most commonly found in the private sector and are prevalent among SMEs and tech startups in modern-day Nigeria.

Sole proprietorships can be registered under Part E of the Companies and Allied Matters Act, 2020, as a business name. This category covers two main types of business organizations: sole trader or sole proprietorship and general partnership.

b. Partnership

A partnership is a startup structure owned by two or more individuals who contribute resources and ideas to operate the startup. Partnerships involve shared decision-making, liability, risks, and profits.

Partnerships can be divided into two main types: general partnerships and limited partnerships. In a general partnership, all profits and losses are shared equally among the partners. In a limited partnership, one partner has control over the startup operations while the other partner(s) contribute capital or other resources and receive only a portion of the profits.

Partnerships can be registered as a business name or a corporation with the Corporate Affairs Commission. The choice between a business name or a corporation depends on the specific needs and goals of the partners.

How to Identify the Right Structure for Your Startup

Choosing the right legal structure for your startup is a critical decision that can impact your startup’s success and growth. To identify the most suitable structure, consider the following factors:

1. Business Plan

Before deciding on a legal structure, it is important to have a well-thought-out business plan. A business plan outlines your goals, target market, strategies, and financial projections. It helps you analyze the specific needs and requirements of your startup and provides a roadmap for its development.

By understanding your business model, industry, and growth potential, you can better assess which legal structure aligns with your objectives. A comprehensive business plan also demonstrates your commitment to investors and stakeholders, increasing your chances of securing funding and support.

2. Memorandum of Association

The Memorandum of Association (MOA) is a crucial document that outlines the objectives and powers of your company. It governs the relationship between the company and external parties and serves as a charter for your organization.

The MOA should be well-drafted and cover all the necessary provisions to protect your startup interests. It is important to consult with a legal professional to ensure that the MOA aligns with the requirements of the Companies and Allied Matters Act, 2020, and safeguards your company’s future.

3. Articles of Association

The Articles of Association complements the MOA and governs the internal affairs of your company. It defines the roles, responsibilities, and rights of directors and shareholders, as well as the procedures for decision-making and control.

Drafting clear and comprehensive Articles of Association is crucial to ensure effective corporate governance and smooth operations within your startup. It is advisable to seek legal guidance to create Articles of Association that address the specific needs and structure of your startup.

Registering Your Startup

Registering your startup is a mandatory step in establishing its legal existence. The registration process involves incorporating your company or registering your startup name with the Corporate Affairs Commission (CAC).

When incorporating a company, you need to prepare the necessary documents, including the MOA, Articles of Association, and other required forms. These documents, along with the prescribed fees, should be submitted to the CAC for review and approval.

Registering a startup name involves choosing a unique name for your startup and providing the required documentation, such as a valid form of identification. Once the registration process is complete, you will receive a Certificate of Incorporation or a Business Name Registration Certificate, which serves as evidence of your business’s legal existence.

By completing the registration process, you gain access to several benefits, including tax incentives, legal protection, and eligibility for loans and grants.

Protecting Your Startup

Protecting your startup is essential to safeguard your intellectual property, assets, and competitive advantage. Here are some key aspects of protecting your startup:

1. Registering Trademarks

Trademarks play a vital role in distinguishing your goods or services from those of competitors. By registering your trademarks with the Nigerian Trademarks, Patents, and Designs Registry, you gain exclusive rights and prevent others from using similar names or logos that may cause confusion among consumers.

Working with an accredited agent or a legal practitioner is advisable to navigate the trademark registration process effectively and ensure that your trademarks receive proper protection.

2. Patents and Inventions

If your startup involves unique inventions or technological innovations, it is crucial to protect them through patent registration. Patents grant exclusive rights to prevent others from producing, using, or selling your invention without your permission.

To register patents in Nigeria, you need to submit an application to the Nigerian Patent and Trademarks Office through an accredited agent or a legal practitioner. This process ensures that your inventions, products, and ideas are legally protected, giving you a competitive edge in the market.

3. Copyrights

Copyright law protects creative works such as literature, music, artwork, and software. Registering your copyrighted materials with the Nigerian Copyright Commission provides you with legal recognition and protection against unauthorized use or reproduction of your work.

It is important to understand the different categories covered by copyright law and ensure appropriate registration for your products, goods, songs, or art that need to be protected.

4. Utilizing the Nigerian Start-up Act

The Nigerian Start-up Act offers a framework for the growth and development of businesses in the country. By leveraging this act, startups can benefit from incentives, funding opportunities, and other support measures provided by the government.

The act encourages innovation, job creation, and investment in startups. It is advisable to explore the specific provisions of the Nigerian Start-up Act that are relevant to your startup and take advantage of the benefits it offers.

Contractual Agreements

Contractual agreements play a crucial role in protecting the interests of your startup and ensuring smooth operations. Here are some important agreements to consider:

1. Pre and Post-Incorporation Agreements

These agreements include shareholders’ or founders’ agreements that establish decision-making powers, ownership rights, and the protection of intellectual property within the company. They define the rights, roles, obligations, and relationships of the founders with the company/startup upon incorporation.

It is essential to draft these agreements carefully to establish clear guidelines and protect the interests of all parties involved. Seek legal advice to ensure these agreements align with the applicable laws and adequately safeguard your startup.

2. Non-Disclosure Agreements (NDA)

Non-disclosure agreements are crucial when sharing sensitive information with external parties. An NDA restricts third-party access to confidential information and ensures that it remains confidential and protected. It is enforceable in case of a breach, offering legal recourse to protect your trade secrets and proprietary information.

3. Intellectual Property (IP) Assignment Agreement

An IP assignment agreement is used to assign intellectual property rights to the incorporated entity for the benefit of the startup. It ensures that all intellectual property developed or acquired by employees, contractors, or founders during their engagement with the company is transferred to and owned by the company.

4. Invention Assignment Agreement

An invention assignment agreement assigns the rights to any intellectual property that may arise during the course of the startup’s business. It ensures that the company owns all intellectual property rights to inventions or innovations created by employees, contractors, or founders while carrying out their responsibilities within the company.

5. Vesting Agreement

A vesting agreement specifies the benefits, authority, obligations, and interests in an asset or property that will accrue to a party and at what time. This agreement guarantees the continuous involvement of the original shareholders for a specified period. If a founder or shareholder decides to withdraw from the company before the specified period, they are entitled to a certain amount of shares as described in the venture.

Conclusion

Starting a startup in Nigeria requires careful consideration of the legal structures available and understanding the associated requirements and benefits. By choosing the appropriate legal structure and taking proactive steps to protect your startup, you can establish a strong foundation for success.

It is crucial to consult with legal professionals to ensure compliance with the Companies and Allied Matters Act, 2020, and other relevant laws. By leveraging the legal framework, registering your startup, protecting your intellectual property, and establishing robust contractual agreements, your startup can thrive in the competitive Nigerian market.

Stay informed about the legal landscape, seek guidance when needed, and leverage the support provided by the Nigerian Start-up Act. With the right legal structure and protection in place, your startup can navigate challenges, attract investment, and achieve sustainable growth in Nigeria’s dynamic startup environment.