The widespread word “start-up” has come to stay. The digital economy has pushed this term forward and now it is strongly associated with innovative affairs.

However interesting, “start-up” in fact is not a practical definition for effective management of real-life business. The term says very little about a business’ legal character, apart from recent but confusing legislation seeking to minimally define it to allow for tax easements or less bureaucracy, but with limited positive effects.

Indeed, a business does not exist in abstraction. It cannot prescind of a formalized, publicly accepted, and identifiable structure before private and public entities.

In essence a “start-up” must present itself as a company subject to minimum legal standards required by a state jurisdiction, as any other enterprise. It must adhere to a legal framework to exist and operate.

A company is the result of numerous and interwoven formal legal relationships identified as relevant and mandatory by this given jurisdiction.

These legal relationships are in practical terms formalized in declarations, signatures, and due acceptance of rules and procedures emitted by competent authorities.

Altogether, these formalities, once fulfilled, grant a differentiated status for this entity – the status of a person – an entity accepted by Law to be subject of legal relationships, able to take part in legal obligations.

In this perspective, the choice of the most appropriate legal structure is one of the most important initial steps of any potential new venture. Shareholders must clearly understand the consequences and effects of such choice for future decisions.  

In my experience in the field, an uninformed or wrong decision on the legal structure may impede the business venture to grow as planned or may even ruin the initiative – irrespective of any potential commercial success.

Commercial Law presents different types of company structures, seeking to fulfil different purposes and expectations.

Apart from certain innovative and off-the-track choices, there is a reasonable consensus in favour of an old but effective model structure, which is that of the limited liability company.

It was conceived as the most pragmatic legal solution for persons to enterprise and run risks together. It is still the best vehicle for personal, small scale business entrepreneurship.

It entails effective commercial flexibility and relatively simple rules of procedure, offering shareholders a clear framework for their relationship and for the operations of the company.

This legal structure is a standard with similar principles, rules, and procedures across many jurisdictions.

It is still the preferred structure for small to medium-size businesses, as most rules are defined beforehand in commercial or civil law codes in a “default” approach – rules for many events and occurrences of company life.

This legislative approach may be interpreted as a protection for shareholders themselves as well as for third parties doing business with the company. It may be seen almost as a legal package for the partners to simply abide to and start operating.

The limited liability company assumes however a rather personal status. This means its legal framework gives priority and relevance to personal relationships among shareholders.

It presupposes the element of personal bondage between its shareholders as the decisive cause for its incorporation and existence – their intuitu personae character, in contrast to increased protection or preference to new capital investment or a clear detachment between management and investment ownership.

Due to such personal character, there may be limitations concerning the functioning of limited liability companies, in pre-existing, legislated rules.

These rules may obviously collide with the expectation of shareholders to capture additional capital for growth or to be able to step in and step out of the company more easily.

We may draw important consequences of this feature, which are not of simple nor immediate solution. I refer for instance to the opportunity of a shareholder to sell a portion of his shares to a third party, or worse, its entirety. Or the case of succession of a deceased shareholder by members of his/her family.

Additional examples of critical situations could be the potential entry via capital increase of a new shareholder, or negotiations for the conversion of a loan of a creditor of the company into shares of the same.

Lawyers must address such potential conflicts in specific terms. They must provide ways for current shareholders to circumvent undesirable effects of unexpected default rules. This legal approach is frequently possible once lawyers identify the applicable default rules and agree beforehand with shareholders on the convenience of replacing such rules for better-suited private procedures, wherever private law allows this replacement to occur.

Using a tailor-made approach, most default rules of replaceable character may be set aside and new, specific rules re-written for the company at hand. These new rules must be incorporated into the company’s statutes and shareholder agreements. Simply put, the limited liability company is prone to be considered a “people venture”, rather than a “capital venture”, and its peculiar legal character makes legal technical adaptations at early stage often necessary for the company to be fully prepared for growth.