What Is Startup Legal? Outside Counsel and Fundraising from Seed to Series A Explained

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

The term "startup legal" covers a wide range of practical work, from founders' agreements and day-to-day contract review to J-KISS, stock options and Series A investment agreements. The legal issues that arise, and the scope of work that should be entrusted to outside attorneys, differ greatly between a company just after founding and one that has completed its Series A.

If you are kept busy only with day-to-day contracts, defects in past shareholders' meeting minutes or the shareholder register may be discovered just before a fundraising round, putting pressure on the schedule up to the payment date. Here I go through the matters to prepare in advance, in order: the founding stage, the seed stage, the Series A preparation stage and the Series A execution stage. If you are considering outsourcing ongoing contract review and fundraising support, you can also check the scope of work and fees for Startup Outside Counsel and Fundraising Support.

Capital Relationships and Contracts at the Founding Stage

The top priority for legal work at the founding stage is the capital structure and the arrangements among the founders, which are difficult to change later. In the case of co-founders, it is important to put in writing, while relations are good, the shareholding ratios, the treatment of shares upon departure (vesting and buy-back clauses) and decision-making procedures. Once a conflict has arisen, it becomes difficult to negotiate terms and reach agreement. This is explained in detail in A Founders' Agreement Can Only Be Made While Everyone Gets Along.

Even when creating the articles of incorporation at founding from a template, check whether they suit your company's situation. Deciding on share transfer restrictions and directors' terms of office, and also thinking about how shareholders' meetings will be run, reduces rework at the next fundraising. In addition, preparing basic templates such as NDAs, service agreements and employment contracts at the very beginning makes it easier to move transactions forward smoothly.

J-KISS and External Fundraising at the Seed Stage

The central issue at the seed stage is the first external fundraising. In domestic seed rounds, J-KISS-type stock acquisition rights (convertible equity) are widely used.

J-KISS is often presented as a method with simple procedures, but the valuation cap and discount that are set determine the key elements of the calculation at the time of future conversion into shares. The actual dilution ratio also depends on the terms of the next round, the total number of shares on a fully diluted basis and so on, but the basis of the formula is fixed at the time of issuance. The overall mechanism is explained in detail in What Is J-KISS? Mechanism, Capital Policy and Points for Founders to Check, and the terms to check before signing in A Checklist Before Raising Funds with J-KISS.

What tends to be overlooked is the practical work at the time of conversion. Under the terms and conditions, the rights are converted into shares through the investor's exercise of rights or the company's acquisition, and in line with the completion of the Series A, the notices and consent documents required for the chosen conversion method and the registration application documents need to be prepared. This is summarized in J-KISS Conversion (Exercise) Procedures.

Contracts such as purchase orders and terms of use also begin to increase from this period. At the stage before placing legal staff in-house, one option is to set up an external legal contact point, as with Legal Outsourcing.

Stock Options and Internal Records at the Series A Preparation Stage

Stock options and internal documents are things you will want to start preparing roughly six months to a year before the Series A. Stock options provide motivation for hiring and retention, but they also affect capital policy. The size of the grant pool is a matter for discussion with investors, and whether tax-qualified treatment is available depends not only on the timing of issuance but also on statutory requirements such as the grantees, the contract terms, the share valuation, the exercise conditions and the custody and management of acquired shares. The approach is explained in Designing Stock Options as Capital Policy: How to Think About the Pool and Grantees, the tax-qualified requirements in What Are Tax-Qualified Stock Options?, and design before the Series A in Avoiding Regrets About Stock Options Before Your Series A.

In a Series A, investors may ask for legal due diligence (legal DD). The scope of the investigation depends on the investor and the size of the deal, but investors check past issuance procedures from documents such as shareholders' meeting minutes and the shareholder register. Since key contracts and labor documents may also be requested, keeping accurate records as a matter of routine makes it easier to respond to checks during the investigation. The points investors look at are summarized in What Investors Look at in Legal DD Around a Series A, and the overall check items in A Legal Checklist to Review Before a Series A.

Preferred Shares and Investment Agreements at the Series A Execution Stage

Let us look at the case of issuing preferred shares (class shares) in a Series A. In an example where separate documents are prepared, the company enters into an investment agreement, a shareholders' agreement and a distribution agreement, and the specific terms of the preferred shares are set by amending the articles of incorporation. The overall picture, including the reasons for choosing preferred shares and the division of roles among the documents, is set out in What Is Fundraising Through Class Shares (Preferred Shares)?. On that basis, the points to check in each document are explained individually in the following articles.

• Designing Preferred Share Terms: Liquidation Preference, Conversion and Down-Round Adjustments
• Key Points in Reviewing Investment Agreements: Practice for the Issuer and Management Shareholders
• Key Points in Reviewing Shareholders' Agreements: Prior Consent Matters, Information Rights and Management Shareholders' Obligations
• What Is a Distribution Agreement? Distribution in M&A and Deemed Liquidation Clauses in Practice
• Procedures for Issuing Preferred Shares: From Amending the Articles and Class Shareholders' Meetings to Registration and Closing

In parallel with contract negotiations, it is important to plan for steadily carrying out the procedures under the Companies Act, such as resolutions of the shareholders' meeting and board of directors, collection of documents and registration. Even if the contract terms have been settled, the mere arrival of funds without the necessary resolutions does not mean that a lawful issuance procedure is in place. Schedule separately the resolutions to be made before payment and the registration to be applied for after payment.

Using Outside Attorneys According to the Growth Stage

What a startup should ask outside attorneys to do changes with its growth stage. At the founding stage, it suits the company to request the preparation of a founders' agreement and contract templates on a one-off basis, and at the seed stage, to proceed with reviewing J-KISS terms and the issuance procedures on a matter-by-matter basis. From the Series A preparation stage, as preparation for legal DD and day-to-day contracts increase, one option is to have ongoing involvement from outside counsel or a legal outsourcing provider that understands the business and its risk priorities. Compare this with one-off requests by considering whether it reduces the burden of explaining the background every time and whether the cost is justified by the expected workload.

When comparing what can be entrusted to a law firm, ask about its experience with fundraising and confirm its typical response times and fees. Please also refer to How to Choose Outside Counsel for a Startup.

At LegalAgent, with a structure that incorporates generative AI into our work, we provide consistent support across this entire period as Startup Legal and Fundraising Support. You can also consult us on reviewing fundraising documents, preparing shareholders' meeting minutes and preparing for registration. Within one business day as a rule is our guideline for the initial response, and the timing of completion is adjusted after confirming the content and the materials required.

Managing Legal Records for the Next Round

Startup legal work becomes easier to see as a whole when understood as the following flow: "fix the capital relationships at the founding stage, use J-KISS appropriately at the seed stage, prepare stock options and internal records at the Series A preparation stage, and complete the preferred share work in the Series A." Please use this article and each linked article when checking which stage your company is at now and what it should prepare before the next round. If you have specific matters to consider or would like to consult us, please contact us through the startup legal inquiry form.

Frequently asked questions

What is startup legal?

It is a general term for the legal work a startup needs at each stage of growth, from founders' agreements and the articles of incorporation at the founding stage, to J-KISS at the seed stage, stock options and legal DD preparation at the Series A preparation stage, and investment agreements and preferred shares at Series A. A distinctive feature is that the topics to prioritize change significantly depending on the stage.

When should a startup first consult an attorney?

The first time to consult is when the co-founders divide up the shares. This is because the founders' agreement and the treatment of shares are difficult to fix later and also affect the terms of the first external fundraising.

What should a company do at a stage when it has no legal staff?

Up to the seed stage, one-off requests on a matter-by-matter basis are often sufficient, but once contracts start arising on an ongoing basis, having an external legal function in a form such as legal outsourcing becomes an option that can be up and running faster than hiring.