The Creation of a Startup in Panama
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:
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 incorporateStartup,S.A., itsArticles of Incorporationmust contain:
∆ Name and address of persons executing said articles before a Notary Public (the “Subscribers”).
∆ Name of the corporation.
∆ Description of theactivity it will carry out, which may beagenericdescription;
∆ 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).
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 areonly 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 thatthe 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 shareswith 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 issuedin 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 responsiblefor the administration of the business.The Directors’ decisionsmust 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 positionand how will they be chosen.
Directors have absolute power over the corporation, aslong 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, forStartup,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 willmanage 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.
Oncenew investorsare allowedinto thecorporation, 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 andoversight of their investment.
Sales of Shares
Theentrepreneurscan sell their shares if they so desire, always subject to the stipulations ofthe Articles of Incorporation.It is common to establish inthe Articles of Incorporation that the shareholders of a corporationmust offer their shares to existing shareholders beforeoffering themto third parties (this is known as a right of first refusal), however it is not a requirement.
If there is no restriction, the sharesof a corporationcan 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 isno such right, shareholders are free to sell or dispose oftheir shares as theywish, without consent of other shareholders or the Board.
In the case ofStartup,S.A., itis 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 whichnew shares and new classesof shareswill be issuedmay be determined at the time of their issuance.
Relationships between Shareholders
Having said all of the above, nothing prevents the shareholders of a corporation from signing a shareholders’ agreement so asto 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 Entrepreneurswould be obliged to adhere to.This agreement would establish, among others,things such as:
∆ Limitationof 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.
∆ Thetypes of shareholders who will have the right to choose the Board of Directors.
∆ The qualifications that a director must haveto 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 orinvestors, may include special rightsand 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 ofStartup, 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 intheStartupSeries.
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:
1. Operations Noticetoenablethe corporationto carry out trade in Panama.
2. Obtaining theUniqueTaxpayerRegistry(RUC) and Tax Identification Number (NIT) in the Office of General Revenue (DGI).
3. Obtaining permits applicable to the operation carried out byStartup,S.A.
4. Opening of bank accounts.
5. Prepare drafts of employment contracts, for when personnel are hired.
6. Trademark registration at theGeneral Office for the Registration of Industrial Property (DIGERPI).
7. Confidentiality agreementsfor Entrepreneurs, employees and contractors.
8. Website terms and conditions, if available.
9. Keep the financial accounting of the corporation, or hire a service to carry it out.
For more information on these matters, please contact:
Kharla Aizpurua O.
Partner, Morgan & Morgan
Tel. +507 265-7777
Miguel Arias M.
International Associate, Morgan & Morgan
Tel. +507 265-7777
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