Starting up in Silicon Savannah

Kenya has fast become one of the leading startup hubs in Africa. With a rapidly growing and dynamic entrepreneurial landscape, Kenya’s silicon savannah has experienced tremendous growth over the past decade. A majority of startups focusing on agriculture, integration of online tracking and logistics management in logistics, retail commodity and e-commerce have been established. In this write-up, we explore the stages that a start-up in Kenya goes through and the legal and regulatory issues that arise.

A startup company is a newly formed business typically in the early stages of operations and founded by one or a few entrepreneurs whose main objective is to quickly develop a scalable business by addressing a specific market gap. Some good examples in Kenya would be M-pesa, the most ubiquitous money transfer service in Kenya and Lori systems, which offers logistics solutions. Startups are innovative and make use of new technologies and their business models and processes are usually a little off the beaten path.
Presently, there have been over 200 startups in Kenya with a majority leaning towards fintech. Despite the boom however, startups in the country still face challenges in terms of the legal, regulatory and economic climate.

The Startup Bill, 2022
While there are no specific laws regulating startups in Kenya, there is a Startup Bill of 2022 which seeks to provide a framework to encourage growth and technological development as well as create a more favourable environment for innovation. This Bill is yet to be passed into law. A link to the bill can be found here.

The Bill defines a startup as a technology based innovative entity, legally recognized by the laws of Kenya, with strong growth potential and a disruptive economic model. The Bill seeks to facilitate investments in and the provision of fiscal and non-fiscal support to startups in Kenya and to promotes an enabling environment for the establishment, development, conduct of business and regulation of startups and incubators. The Bill also seeks to subsidise the formalization of startups, give research and development support as well as facilitate the protection of their intellectual property.

Though the aims of the Startup Bill are welcome in enhancing the Kenya startup ecosystem, we feel the Bill does not go far enough. It does not offer tax breaks for startups but merely alludes to measures being put in place for tax incentives. It also alludes to the Cabinet Secretary for science, technology and innovation making regulations for exemption of startups from registration fees and attracting foreign investment without offering concrete timelines for this under the Bill.

We at SMC would have liked the Bill to go further by, for example, exempting startups from labour inspections, fast-tracking incorporation of startups and allowing the creation of regulatory sandboxes.

The startup lifecycle and factors to consider at each stage
While specifics vary depending on the type of business, the generally agreed upon stages of a startup’s lifecycle are as follows:

1. Conceptual/Ideation Stage of a startup:

At this stage the entrepreneur or key founder has a good idea. He has already grappled with the fundamental questions: Does my solution address a real problem? Is my solution similar to one that already exists? Who is my ideal customer? It is a good idea to sort out any necessary agreements, intellectual property rights, or other legal issues as early as possible? He is ready to undertake confirmatory market research centering around a viable product and a viable business. At this stage, the entrepreneur needs to make a raft of decisions such as:

1. The best vehicle for the business: should he form a company, a limited liability partnership or simply register a business name as a starting point. The type of structure chosen can have significant legal and tax implications for a business.
   For example, in Kenya, while a company is the most widely used vehicle for a business, a limited liability partnership (LLP) has the advantages of a company such as that it is a body corporate with a legal personality separate from that of its partners and can hold assets in its own name however it is treated as transparent for most tax purposes. This means that the activities of the partnership are treated as carried on by the individual partners and not by the partnership as an entity hence no double taxation. An LLP could therefore be an even better vehicle for a startup in some circumstances.
2. Intellectual Property Protection: startups depend on innovation for their competitive advantage in the market. As a result, brand and intellectual property protection is a cornerstone in a startup’s success. Apart from enhancing brand recognition and preventing theft of the business idea, intellectual property can attract funding for the business. When commercializing the core idea of the startup, especially the technology, an entrepreneur will need to present their opportunity to people with the funds to help them make it happen. These can be venture capitalists, angel investors and perhaps initially, friends and family.
   An investor in a startup is investing in the idea and it is crucial that the idea on which the startup is riding is legally registered. Such registration protects startups against infringement and allows entrepreneurs to monetise their idea through licensing. What most startups overlook is that safeguarding intellectual property is much easier in the beginning of the business than after the success of the idea.
   Despite most startups in Kenya relying on software application as the core startup idea, a lot of entrepreneurs do not bother to register their copyright with the Kenya Copyright Board, a process which can take 14 days. In Kenya registering a trademark or an industrial design can take up to 6 to 8 months.
3. Licensing: It is necessary to obtain the necessary licenses and permits for the business such as county business permits. It is important to engage competent legal advisors who can guide you on sector specific laws that apply to your startup. For example, in Kenya persons who are not architects or quantity surveyors cannot hold more than 50% shares in an architectural or quantity survey firm or business. If a startup is operating in this field, they need to be aware of this from the start as they will not be registered unless they comply.

2. Startup/Launch Stage:

At this stage, the startup is officially launched but there is high uncertainty as to chances of success. Since the business entity is up and running at this stage, the entrepreneur has to juggle issues such as:

1. Corporate Compliance: The business must comply with all relevant laws and regulations. Most laws do not have exemptions or safe harbour provisions for startups. A good example would be the Data Privacy Act, 2019. The fines and penalties under the Act range from KES 3,000,000 to KES 5,000,0000, a sum which could sink a startup. With a majority of startups being tech-based and necessarily needing to collect personal data of customers and individuals, it is necessary to comply with the provisions of this Act to the letter.
2. Contract Drafting and Review: A startup will need to get into a raft of agreements at the beginning such as venture capital deal terms, shareholder agreements, management rights agreements, convertible debt agreements. All these agreements need to be thoroughly reviewed by competent legal counsel to ensure that the interests of the founders are protected.
3. Employment Law Compliance: In Kenya employment courts have taken a pro-employee stance which means there is a larger burden on employers to strictly follow employment processes and laws. A good example would be terminations and redundancies. If start-ups do not follow the legal procedures when implementing terminations and redundancies, they could find themselves sued and having to pay a lot of money by way of damages for unfair or unlawful terminations. It is usually a good idea for start ups to explore consultancy relationships as opposed to employment especially during the testing period before they have made the decision to permanently take someone on.
4. Leasing and Real Estate Issues: a startup will need to lease office space or real estate for its operations. A startup needs to protect itself from being tied up in long lease terms at the beginning because there is uncertainty as to whether the business will survive beyond three years. In Kenya for example, where landlords are fearful of introducing break clauses in leases because this creates controlled tenancies under the Landlord and Tenants (Shops, Hotels and Catering Establishments) Act (Chapter 301 of the laws of Kenya), a startup lawyer could negotiate a side letter that allows a termination outside the terms of the lease.

3. Growth Stage:

Here the startup has proven itself as a viable business model is now centered on growth and scaling up. At this stage the startup is hiring more staff, expanding its customer base, and increasing its revenue. At this stage the startup may opt for Series B funding to take it to the next level as it may need more funding to achieve its growth objectives. The startup is focusing on risk management because as the startup grows it may start to grapple with contractual disputes, regulatory compliance issues or intellectual property infringements.

4. Maturity Stage:

During this stage, the startup will have a well-established customer base, a solid revenue stream, and a strong brand identity. The startup will also be focused on optimizing its operations and improving its profitability and will have high human resource support and funding needs. Here, the startup may explore Series B or C funding.

5. Decline/Renewal Stage:

This is the stage where the startup faces declining revenue and market share. During this stage, the startup will need to make significant changes to its business model or product/service offerings to remain competitive. If the startup is unable to adapt, it may ultimately fail. At this stage, the founders must think about:

1. Restructuring and Renewal: The founders need guidance on restructuring the business to adapt to changing market conditions or to explore new opportunities. This can take the shape of mergers, acquisitions, or joint ventures that can help revitalize the business.
2. Debt Management and Bankruptcy: If the business is facing financial challenges during the decline stage, the founders require guidance on debt management, negotiation with creditors, or even bankruptcy proceedings if necessary.
3. Exit Strategy: If the decision is made to wind up the business, a startup will need to go through the process of dissolution which will involve asset distribution, employee terminations, and other legal aspects of closing the business.

A startup lawyer is invaluable at every stage of the startup journey. Startup lawyers essentially act as outside general counsel for startup companies: counseling the entrepreneur or founder through the formation process and capital raising from angels and venture capitalists and advising on legal and business issues that arise as the companies scale and grow.

At SMC, with a keen awareness that startups are grappling with funding and cashflow at the start, we have an all-under-one roof package designed specifically for startups that offers support through the following stages:

• Formation of an entity
• Compliance with the relevant laws
• Getting the requisite licenses and permits
• Drafting of Contracts with founders, VCs, employees, vendors or service providers.
• Employment-related compliances
• Company secretarial services
• Ad hoc tax support
• PAYE statutory deduction compliance as well as accounting support.

If you are looking to set up a startup in Kenya, please reach out to Divinah Ongaki for more specific advice.