In our latest Startup essentials article, we discuss the importance of having a robust shareholder and founder agreement in place. With founder fall outs all too common, Helen Goldberg, COO at our partner Legal Edge gives you the lowdown on what needs to be covered in this essential agreement.
You’re busy building and growing a business, so shareholder and founder agreements are often deprioritised, forgotten or overlooked while you’re deep in product development or GTM strategy. While you may opt for a verbal agreement and trust in long-term commitment, it is essential to have formal agreements in place when working with co-founders and investors.
Why?
Sadly, because founder fall-out is so common and it can be catastrophic.
You won’t believe it will happen, but it does, often. As a company grows the potential for diverging ideas on how to run it increases. And if there is a serious disagreement where founders can no longer agree on how to work together:
1. It will be difficult or impossible to find an agreed way forward;
2. The business becomes hamstrung and difficult or impossible to run;
3.It then becomes difficult or impossible to attract investors.
You need a mechanism to address the issue swiftly, including a legally enforceable ability to remove a founder and recover some or all of their shares. This is where terms you have likely heard of come into play, such as good/early/bad leavers, (reverse) share vesting, cliffs, etc. Institutional investors require them for a good reason. It is essentially similar to a ‘pre-nup’.
What absolutely needs to be covered?
Cap table management
These clauses help keep your cap table under control, which is key when heading towards later stage investment and/or an exit (sale/IPO). Incoming investors hate seeing ex-founders holding a significant %, and it can affect valuation and/ or put them off investing.
It can also cause admin problems when trying to get sign off from disaffected shareholders, which you’ll likely need to do every time you fundraise. So having a mechanism to take or buy back their shares is key, and they can then be used to incentivise new hires without diluting existing shareholders.
What else should be covered?
Decision making
In the early stages decision-making is informal. However, investor shareholders will often want a say in how big decisions are made, like board changes, budgets, high level hires, etc., even if they’re not on the board. And as the company grows, clarity in governance becomes more important.
Founder commitment
Founders need to be fully committed to the business. If not and/or they leave, you need to protect the existing business by having restrictions in place stopping them from setting up in competition, taking know-how, staff, clients etc.
Reporting requirements
This sets out the information all/major shareholders will want to receive, usually monthly, regarding the business: revenue, spend, performance, customer acquisition, product development, staff.
Planning for a smooth exit
Minority shareholders should have ‘tag along’ rights so they can participate in a sale of the business, and majority shareholders will want ‘drag along’ rights so they can force the minority to sell if the board/ majority decide to do so.
Don’t leave it too long. Don’t let this slip down your list of priorities, investing in it early on will save time, stress and potentially significant legal, accounting, etc fees in the future. This can also be called or covered in an investment agreement or Articles of Association.
LegalEdge is a fractional legal counsel service. Using people, processes and tech, the team set up and run cost-effective efficient legal functions for fast growth companies. Their experienced in- house lawyers focus on what’s important and proactively manage legal strategy, workflow and budget. They prioritise and triage legal and compliance work to speed up contract negotiation.
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