The Australian startup scene needs to talk about pre-emptive rights

It should come as no surprise to anyone active in the Australian technology industry that we are behind the curve in terms of investment norms. Just one example of this the expectation of “pre-emptive rights” as an standard right for all investors.

In short, a pre-emptive right is the right for an investor in this round of investment to participate in all future rounds of investment.

Australian investors, (or perhaps just their lawyers) are absolutely obsessed with pre-emptive rights, and we see them come up again and again in negotiations, often as the first thing to be discussed.

Now, that doesn’t sound so bad, right? What company wouldn’t want their existing investors to double down on their investment later at a higher value, saving them from the trouble of going to market for the same funds?

Well, unfortunately, these pre-emptive rights often look something like this:

  1. The startup must determine the terms of the proposed investment round;
  2. The startup must offer each Investor its respective proportion of shares on the terms of the proposed investment round;
  3. The Investor has 30 days from receipt to confirm its interest.

How does this play out in practice?

Let’s work through a couple of quick scenarios with respect to how this might play out in practice with a hypothetical startup.

Scenario 1 - Approaching existing investors in advance

This scenario lays out the process as envisioned by the pre-emptive rights clause as drafted.

The startup decides for itself the terms of its proposed investment round in advance of approaching any outside investors, a contract is drafted, and offered to all of its existing investors as required by the pre-emptive rights clause. (14-21 days)

The startup waits for each investor to confirm its interest or refuse. (30 days)

At the end of the waiting period, a portion of the proposed investment round is taken up by existing investors, and the balance needs to be sought from the venture capital market.

VCs are willing to invest, but after a period of negotiation, require changes to the proposed terms on some axis (price, valuation, share type, etc). (20-30 days)

The startup is now required to make a new offer to all of its existing investors, as the terms of the investment have changed.

The startup waits another 30 days for each investor to confirm its interest or refuse the new deal, during which time, the deal may go cold.

Total wasted time: 60 days.

Scenario 2 - Approaching existing investors after terms are decided

This scenario lays out the ideal outcome for a startup.

The startup directly approaches the market without first consulting its existing Investors, pitching to VCs (20-30 days).

VCs are willing to invest, and a contract is drafted and terms of the investment are decided after a period of negotiation (20-30 days).

The startup takes the VC’s offer to all of its existing investors as required by the pre-emptive rights clause.

The startup waits for each investor to confirm its interest or refuse, during which time the deal may go cold. (30 days)

If the terms of the external investment do not perfectly match the expected uptake of the pre-emptive rights from then either:

  1. the round is over subscribed; or
  2. the incoming VC’s investment is reduced, which may cause the deal to go cold;

Total wasted time: 30 days.

How do we solve this problem now?

There is one “easy” solution to this problem, and that is for founders to pester their existing investors to waive or take up their pre-emptive rights as soon as possible after a deal is settled.

This is an “all or nothing” proposal however, and if a single shareholder refuses or can’t be contacted, the whole 30 day period must be waited out.

If a startup has a handful of existing investors, this works. Given that the number of shareholders is likely to increase over time however, this is only a viable solution for so long.

How do we fix this for good?

Ideally, we would like to see a future more like the United States, where pre-emptive rights are not the norm, but rather a reward for high value investors.

In the mean time, we think the answer to this problem is a standardisation of “pay to play” provisions in venture deals in Australia.

Pay to play provisions are also more common in the US, and will usually look something like this

  1. Only “Continuing Investors” will have pre-emptive rights;

  2. If a “Continuing Investor” fails or refuses to participate for at least its pro-rata proportion of shares in any future fundraise, they will cease to be a Continuing Investor;

We believe that pay-to-play provisions are good for both investors and startups.

  1. For the startup, it reduces, over time, the administrative headache of each subsequent round;
  2. For the investor, it gives them an incentive them to continue to support and participate in a successful business.

Why the AVCAL Shareholders Agreement probably isn’t right for your startup

While every business is different, many of the startups that we work with have a few things in common:

  1. There are two (or more) founders;
  2. They have taken some initial investment from family and friends;
  3. They are building out a product, and intend to seek formal venture funding;

Since they were released in 2015, the Australian Venture Capital Association Limited (AVCAL) Seed Round docs have been very popular. The stated goal of the documents is to:

short-cut the “to and fro” of trading documents and use a set of documents as a balanced, well-informed starting point - ideally with time and costs being reduced significantly

I commend our colleagues at K&L Gates for their hard work - I think they have succeeded in this goal of setting some useful standards for the venture capital industry in Australia. Working on the startup side, we have found that the AVCAL terms commonly set useful benchmarks for investment discussions.

The documents have become so well known that our clients often come to us with the AVCAL Shareholders Agreement already sourced and signed. Unfortunately, Shareholders Agreements require unanimous consent to amend, so it has been our experience that an inappropriate shareholders agreement is often worse than no shareholders agreement at all.

Here are some of the things we think it’s important for startups to know, before they implement anything:

  1. the AVCAL documents assume there will be “Seed Round Investors”, and that they will be taking “Preference Shares”. That might not be true for your business, and even if it does have an investor, it may be too soon to be handing out preference shares.

  2. founder vesting starts when you sign, regardless of how old you business is or how much money you’ve personally funnelled into the business. You can set the percentage (its marked up), but even so, this might be fine for some, but not everyone (or even everyone equally within a single business).

  3. the list of business decisions requiring the agreement of 75% or more of the board are pretty exhaustive. If you have investors on your board, this means a substantial loss of day to day control. If you don’t, it means keeping extensive records of meetings with your cofounders - something nearly nobody does.

  4. The document gives right of first refusal on new issues of shares to all shareholders. If the company is closely held, no big deal, if you have a lot of shareholders (or might in the future), you’ll want to restrict this right - it’s quite onerous chasing down waivers from countless smaller investors, or having to wait out a notice period before you can close an investment round (that might go cold!)

The long and short of it is that these documents are to support a seed fundraise from a formal venture capital fund (or a sophisticated group approximating one). Until that time comes, a simpler shareholders agreement might be more appropriate.

Australian translation of Y-Combinator's Simple Agreement for Future Equity (SAFE)

We were recently asked to take a look at Y Combinator’s Simple Agreement for Future Equity ("SAFE") for Sparrow Flights, one of our clients and a great new startup based in Sydney.

The SAFE is a fantastic instrument released by Y Combinator to, as much as possible, replace convertible notes. It was prepared by James Riley at Goodwin Proctor. In Y Combinator's own words:

The safe (simple agreement for future equity) is intended to replace convertible notes in most cases, and we think it addresses many of the problems with convertible notes while preserving their flexibility.

An investor makes a cash investment in a company, but gets company stock at a later date, in connection with a specific event. A safe is not a debt instrument, but is intended to be an alternative to convertible notes that is beneficial for both companies and investors.

In our experience at Viridian Lawyers, convertible notes (and related instruments) have had midling uptake in Australia. They are used only occasionally, and even then, usually as bridging finance shortly before a "real" round. In this respect (and a few others), we're lagging behind the rest of the world; fixed size, multi-investor angel rounds are an exhausting way for an early stage startup to raise funding.

The SAFE is a very compelling instrument for startups and investors for exactly this reason, and we think it has a lot of value for the Australian ecosystem. Some key advantages of "future equity" instruments include the ability to:

  1. avoid fundraising deadlocks;
  2. close funding rounds faster, and with less back and forth;
  3. offer higher discount rates to high value or early investors;
  4. avoid premature valuation, or non-sense valuations, of great but early stage businesses.

In translating the SAFE for use in Australia, one of the goals of the exercise was to change as little as possible.

Any changes that we make to the SAFE would be at the expense of consistency, and at the potential expense of industry acceptance. Too many changes would open the door to further amendment and negotiation - and that defeats the purpose of these documents. These documents are standard, a standard that is supported by Y Combinator's reputation. The role the SAFE serves is to set a base line that can be agreed upon broadly, and that standard has now been imported into Australia.

We believe that an Australian startup can now have a multiple SAFEs on their books with investors in Australia and the US, and for nearly all intents an purposes, treat those relationships as functionally the same.

For these reasons, we like to think that as much as possible, this is not a Viridian Lawyers document, this is a Y Combinator document, we just helped it along.

We'll have a blog post up in the next few days detailing our methodology, including some of our reasoning, and we'll include a clear comparison of Australian and Original version of the SAFE Agreements - until then,

  1. Safe: Cap, no Discount
  2. Safe: Discount, no Cap
  3. Safe: Cap and Discount
  4. Safe: MFN, no Cap, no Discount

A copy of the original SAFEs can be found at Y Combinator's website, and the SAFE Primer document can be found here.


You should also know that these documents are provided without any warranty, express or implied, to the fullest extent possible.

Because Viridian Lawyers hasn't had the opportunity to meet with you and discuss your needs, this document should not be considered legal advice, or advice specific to your circumstances.

Please read these documents very carefully before using them. We suggest that you seek professional legal advice to assist with implementing these documents.

Terms of Service

Can I copy another website’s terms of service?

Being an entrepreneur is all about innovation and efficiency. What some people call "shortcuts" you would call "smart business". That's part of what makes launching a business so exciting – but also risky.

So when the day finally comes to launch online, in an attempt to be more efficient it might be tempting to just copy another website's terms of service. It saves time, and anyway, no one really reads them.


Wrong. While it might seems like a time-saver in the short-term, copying another website's terms of service can have serious legal consequences down the track. This post will outline why it's a bad idea to take this particular shortcut, and why it's well worth the investment of getting legal advice on your Terms of Service.

1. "Terms of Service" are legal documents

The terms of service are a legal agreement between you and the user. That's why it is always important to know what clauses are in there – no matter which side of the agreement you are on. Once you've had to write your own, it's likely that you'll start to read other Terms of Service agreements a lot more closely.

As a contract between you and the user, it will outline things like:

  • Data collection
  • Responsibility for the data you store
  • How you will use the data
  • Payment terms

If anything goes wrong and you face legal action from a user, the Terms of Service document becomes crucial to show what each party agreed to in advance.

2. Breaching copyright

Another reason not to copy is pretty obvious – you are breaching the other website's copyright. Just like other written content, you retain copyright in terms of service, even if they all look pretty similar at a glance. It's possible to find some open-source terms of service, but it's always best to consult a lawyer to look into using one of these or drafting an original one.

3. Data Use

It's common practise for websites to collect and store, or even on-sell, user data. However, unless there is consent from the user this collection could be in breach of the Australian Privacy Principles.

Clearly, a website that sells clothing will need to have different terms of service to that of a ride-sharing app, for example. It's important to make sure your Terms of Service are specific enough that the user knows what is really happening to their data. Otherwise, they are not consenting to the use you intended.

If you are collecting large amounts of data, it's also worth looking into having a separate privacy policy. Some businesses need to have privacy policies simply because of the other applications and software they use. 

So there you have the main reasons it is well worth the time and effort of drafting your own Terms of Service. Like all legal documents, it's best to have these done or at least vetted by a lawyer. It's an up-front investment that can save you time, money and liability down the track.

New Australian Employee Share Schemes

Briefing on the New Australian Employee Share Schemes

From July 1, 2015 the Australian Taxation Office brought in new rules for Employee Share Schemes (ESS). The reforms have brought Australia in line with other developed nations, and are especially great news for start-ups who want to reward or incentivise talented employees with a stake in the company.

What is an ESS?

Employee Share Schemes (ESS) are formal written policies. They allow employees to purchase shares in the company they work for at a discounted price, and/or the opportunity to buy shares in the company in the future (a right or option).

Note: Employee Share Option Plans (ESOP) is a term commonly used for these schemes, especially internationally. However, in the Australian legislation they are called "Employee Share Schemes".

Changes to the existing rules

There are a number of changes that will apply to all ESS interests – that is, shares, stapled securities and rights to acquire them.

The main changes are:

  • Deferred taxing point for ESS interests (in certain tax-deferred schemes)
  • Changes to the test for significant ownership or voting rights limitations
  • A tax refund will now be possible if an employee does not exercise the rights they acquire

Start-up tax concessions

The main benefit for start-ups is a new tax concession. This is an exciting development that finally makes these plans usable for start-up companies.

Prior to these reforms, when you received equity "for free", the market value of that equity was taxable when you received it. Now it can be taxed when you sell that equity instead – a much more favourable tax treatment for start-ups, as long as certain conditions are met.

The term "start-up" is not defined in the legislation and it's not limited to any one particular type of business. However, in order to be an "eligible" start-up, there are strict requirements your company will need to meet.

The most notable thing about implementing an ESS, is that the tax concessions will not apply to someone who owns more than a 10% stake in the company. In other words, these are designed for new team members rather than company founders.


There are strict requirements that need to be met to qualify as a start-up company that is eligible for the concession:

Start-up company:

  • The company must be an Australian tax resident and not listed on a stock exchange
  • The company (and all companies in a group) must have been incorporated for less than 10 years
  • There must be an annual turnover of less than $50 million per annum in the year the securities are issued


  • It must be a requirement of the ESS that the securities are held for at least three years, or until the holder is no longer employed by the company

ESS Interests:

  • If the ESS grants shares as well as options, it needs to be available to at least 75% of employees that have been of service for three or more years
  • Any options that the company is offering must have a value that is equal to, or higher, than the current market value of an ordinary share (these will still be considered as shares offered "at a discount" for tax purposes)
  • Any shares that the company issues must have a discount of less than 15% of the market value

When the shares or options are exercised by the employees, and the resulting shares are sold by the company, any capital gains by the employees will be subject to capital gains tax (CGT).

This is where the discount for start-ups really helps out. For eligible start-ups, if the share has been held by the employee for more than 12 months (with other requirements) then they can get the 50% CGT relief – that is, they can potentially halve their effective tax rate.


What is an End User Licence Agreement?

What is an End User Licence Agreement?

For those working in software development, it can be hard to know how to protect your intellectual property. On the one hand, it is in your interest to make your product available for users online. Yet on the other is the risk of unauthorised distribution, use and even reverse-engineering by a competitor.

There is no complete fix for these problems. However, from a legal perspective, you can protect yourself in a number of ways. The most common way, particularly for software, is through an End User Licence Agreement ("EULA").

Essentially, this is a contract between you (the developer) and the user. It allows the purchaser to use the software, but places restrictions on exactly how it can be used. It is particularly useful to protect your copyright in any software you develop and then make available for purchase.

Unlike other forms of property, software is more often licensed than sold. Users rent the software subject to the terms of a EULA. This ensures that the consumer gets to use the product, but that you as a developer retain control over it.

Click-wrapped EULAs

You have probably encountered many EULAs online before, as they are almost a standard part of any closed-source software. You know those long documents that pop up before you install a new program? Those are click-wrapped agreements. When you click "I agree" you are agreeing to the terms in the EULA.

This is a pretty handy form of contract. It's much quicker and easier than mailing a copy to each user and having them send a signed copy back (though this is an alternative option).

Common terms and restrictions

Some common restrictions on software use include preventing:

  • Copying of the software
  • Modification
  • Reverse-engineering
  • Unauthorised distribution
  • Using the software for unlawful purposes
  • Using deep-links, robots, spiders or page-scraping 

Of course, simply having these terms in a contract doesn't magically mean you will be able to prevent people from doing these things. Often companies rely on a legal contract as well as the architecture of the software to prevent such activity.

But what the EULA can do is provide a way of enforcing your rights after something goes wrong. It's well worth ensuring you are protected from the outset by drafting a EULA before making the software available to users.

Issues with click-wrapped agreements

The downside to these kinds of EULAs is that most people don't read those boxes when they pop up. They just click "agree" and move on – which is not the best idea.

But software companies also share part of the responsibility for ensuring that their agreements are easy to understand and not arduous in length. Companies like Paypal and iTunes have been criticised for their extremely complex, long and intimidating EULAs.

At the end of the day, if the user has clicked "agree" they have agreed. But if you want to stop them from infringing a term in the first place, it's a good (not to mention, ethical) idea to make those terms clear.

Protecting yourself, as well as your software

While this article has mainly discussed how EULAs can protect your interest in your software, there is a flipside as well. Namely, they can be necessary to protect yourself if the software is used for unlawful purposes – for example, the unauthorised copying of sound recordings.

However, the Federal Court of Australia have made it clear that simply having this kind of term in your EULA is not enough. As the court held in Universal Music v Sharman Networking, if there is a term in the agreement that is being ignored by users, and no further action is being taken to prevent the unlawful use of the software, you might be liable for that use.  This will depend on whether you have "authorised" copyright infringement, which can be difficult to establish, but is still a risk for certain software developers.


Who needs a privacy policy?

Who needs a privacy policy?

Privacy Policies. They sound like a pain – and if you've ever tried to read (or decode) one, you'll know that they can be pretty arduous to make sense of.

But for many small companies, they are essential – especially if you're start-up is an app or an online service that handles personal information. Under the Australian Privacy Principles, if you are an APP Entity, you need to have a Privacy Policy.

APP Entities include:

  • Businesses with an annual turnover of more than $3million (not including assets held, capital gains or proceeds of capital sales)  
  • Small businesses with a turnover of less than $3 million are not considered APP Entities. However, it will still need a privacy policy if:
    • Your business collects and trade personal information without the consent of the individual
    • Your small business is a health service provider
    • Your small business is required to comply with the data retention provisions under Part 5-1A of the Telecommunications (Interception and Access) Act 1979

No matter which category you fall into, it is still a good idea to have a Privacy Policy in place. It increases consumer trust in your business and how it handles and protects personal information.

Similarly, if you your business uses external services, you may be required to have a privacy policy under their terms. For example, section 7 of Google Analytics' terms of service requires that you have a privacy policy in place.

What is a privacy policy, exactly?

A privacy policy is a document that outlines how your company collects and uses personal information. There are topics that it needs to cover under Australian privacy laws, and should be easily accessible to anyone – the idea is that you show how you manage personal information in a transparent way.

On that note, it's not a document that should be drafted to mitigate risk in heavy legalese. It's something that should build trust between the company and people whose information you are collecting. It should be easy to read and reflect the company and its values.

Topics that a Privacy Policy must cover include:

  1. The kinds of information you collect and hold
  2. How you collect personal information
  3. How you hold personal information
  4. The purposes for which you collect, hold, use and disclose personal information
  5. How an individual may access and correct their personal information
  6. How an individual can complain if you, or a contractor, breaches the apps or a binding registered app code
  7. Whether you are likely to disclose information to an overseas recipient

The best way to present this information is in layers. Use headings such as "scope", "collection of personal information" and "disclosure" to make it easier to understand for the user.

Personal Information

So what is personal information? It's a very broad term, and captures any information (or opinion) about a person who is reasonably identifiable, or is identified.

Examples include:

  • Name
  • Address
  • Phone number
  • Bank account details
  • Opinions

What happens if I don't have a Privacy Policy?

If you don't comply with the Privacy Act 1988 as required by law, an individual can make a complaint about your company to the OAIC. They have the power to investigate, conciliate and make determinations based on the complaint.

Breaches of the Australian Privacy Principles can result in civil penalties, and repeated breaches of the law in large fines. This can be $360,000 for individuals and up to $1.8 million for corporations.

So even though it might take a little time or initial cost to produce a great privacy policy, it's clear that the effort is well worth it. It's not just about avoiding penalties, but making your company trusted and transparent in it's information dealings. 


What is a Shareholders' Agreement?

It's a pretty simple question, and it has a pretty simple answer: as the name suggests, it's an agreement between shareholders in a company.

Perhaps the more important question, particularly for tech companies and start-ups, is: why should I have one?

Setting up a company is all about risk. Usually in the start-up and small business space, people talk about risks related to finance, their intellectual property and their business relationships. But what about mitigating risk at certain stages in the natural life of a company, such as when you have to make a crucial decision that your co-owner doesn't agree with, or if one of you wants to leave the company?

If you're a start-up looking for funding, having a shareholders agreement in place will also signal to investors that you've considered and handled your business affairs in advance, and improve your bargaining position.

These are the situations where a shareholders' agreement can protect you, and your company. It's a set of rules to follow when things change, grow, or go wrong.

Do I need a shareholders' agreement?

There is no requirement under Australian law that companies have a shareholders' agreement. They are treated as a private contract between parties. This means there are a number of benefits for companies, particularly small ones where the owners are also the shareholders. These include: • Protecting shareholders in a wide variety of situations • Flexibility in crafting terms to suit the company's needs • Contract remedies for breach of terms • Ability to keep the terms of the agreement confidential

Common terms that go into an agreement

There is no one-size fits all shareholders' agreement, which is part of what makes them so appealing for dynamic and innovative companies. The most important part is that the agreement is drafted clearly, to remove any ambiguity. This is where having a lawyer involved is helpful.

Having said that, there are a number of common provisions that go into a shareholders' agreement. They can roughly divided according to the life cycle of a company:


  1. Ownership of the company/recording shareholdings – who owns which shares, and are there any special rights that attach?

  2. Sharing profits/dividends - When and how will dividends be paid, if at all?


  1. Control and management of the company –

    1. Who can be elected to the board of directors

    2. Right of shareholders to appoint/remove nominee directors

    3. Circumstances under which directors can be removed or held personally liable for their decisions

  2. Issuing new shares

  3. Class rights – Creating different classes of shares, enabling founding shareholders to retain greater control of the company.

  4. Transferring shares – Mechanism for the transfer of shares, and events that give a party the right to call for a transfer of shares.


  1. Rights of First Refusal - Exiting shareholders are obliged to offer to sell their shares to one of the other shareholders first before placing them on the market.

  2. Non-compete clause – A shareholder who wants to leave the company can be prevented from working for a competitor. This is particularly important for those who have a few different business ventures happening at once, and when knowledge of business plans and clients lists is highly valuable.

It's hard to imagine things going wrong when starting a new company. However, having a way to navigate tricky territory from the outset is always better than trying to fix things retrospectively. It'll also be far less expensive to have a well-drafted set of rules now than to litigate if things take a turn for the worse.