A startup entrepreneur may heave a sigh of relief when finally signing an investment contract, taking it as a tangible solution to the numerous uncertainties lying ahead of the budding business.

But it is especially at this stage that one should take the upmost guard, looking out for possible “toxic clauses” which may deliver irrevocable consequences upon the business in moments of crisis, according to lawyer Roh Jong-eon.

“People, most of all startup founders who are new in the business realm, tend to be intimidated by legal contracts,” Roh told The Korea Herald in an interview.

“These novice businesspeople also get easily carried away by the investment itself, which may mislead them to overlook some critical clauses in the contract.”

Roh, former head of the legal department at Mirae Asset Global Investments, is currently working as a lawyer at Help Me, a startup providing low-cost legal consultation via an online platform.

“All investors, whether individual, venture capital or private equity, base their action on the fear of losing money and the goal of creating large profits from their investment,” the legal adviser said.

“It is thus only natural that startup investors should insert protective clauses so as to build a buffer zone against possible losses.”

In the investee’s perspective, however, these preventive measures turn out to be toxic clauses to infringe on management rights or impose excessive damage compensations.

While the responsibility lies in both parties to take due precaution, it is usually the startup entrepreneurs who find themselves in a weaker position compared to experienced investors, the lawyer explained.

An example of such a toxic clause is a ring-fence on investment which restricts the use of money to specific purposes or bestows on the investor the consent right on the company’s key decisions such as the appointment of directors.

“These are usually the kind of clauses which trigger conflict in investment deals as the investee, who is also the founder and major shareholder of the company, refuses to be bound by minority shareholders’ interest,” he said.

The expert also advised investees to double-check on the format of damage compensation as a contingency plan.

“What should be avoided at all costs is a penalty clause, which obligates the business operator to pay an extra amount, along with the actual damage compensations,” he said.

“In case of a fixed amount compensation, one should make sure that the figure is not excessive compared to industry average.“

Another intrinsic risk is the “drag-along right,” which allows the investor to sell off the major shareholder’s share unless the company goes for initial public offering within a given time.

Even conglomerate affiliates have at times suffered from these contract conditions.

Upon signing an investment deal with Doosan Infracore’s Chinese affiliate DICCin 2011, investors inserted a drag-along clause to guarantee their rights to sell off Doosan Infracore’s shares, should DICC fail to go public by March 2014. The legal battle over the legitimacy of this contract is yet pending at Seoul’s appeal court.

“Despite the complicated contract terms, it all comes down to two questions for entrepreneurs -- under what circumstances will I be liable for damage compensation and how much will I have to pay in that case?” Roh said.

For small-sized startups with limited funds, time and manpower, the lawyer suggested that they consider partial legal consultation as a valid alternative to save costs.

“The legal circles have been evolving out of their old practices and there are now an increased number of ways to get legal counselling at a more reasonable cost,” Roh said.

Help Me kicked off in 2015 as an online legal consultation platform, allowing the user to scan the lawyers on the list, apply for an online consultation and pay on an hourly basis.

“Korea’s legal market remains in that transition stage, where the number of lawyers has soared but the service level is yet underdeveloped,” said Park Hyo-yeon, one of the three co-founders of the business.

“One of our goals is to open up the market to a broader public via a low-cost, open platform.“

By Bae Hyun-jung (tellme@heraldcorp.com)


The Korea Herald publishes a series of articles looking into the new roles of South Korean startups en route to the ‘fourth industrial revolution,’ and their challenges in securing funds, entering the market and staying in it. This is the second installment. -- Ed.