The life of building a start-up business is intense. You’ve come up with a concept and an idea and invested blood, sweat and tears in developing it into a marketable opportunity. You may have had fellow founders join you at the start of this journey and others join you along the way, all of whom have in some way shared the struggles of your endeavour. Those relationships are vital to the success of your business and often include friendships and emotional connections; all working collaboratively to achieve a common goal – the success of the business.
The intensity we recognise in a start-up can sometimes mean relationships falter
The litigators here at Ignition Law unfortunately often see businesses that start their journey with everyone contributing positively and on good terms, become hampered by disputes amongst shareholders and founders. The effect on the business can be catastrophic; founders and key individuals becoming distracted and not able to focus their efforts on building the business, working capital is wasted on funding legal disputes, potential investors are put off by a divided management team, and ultimately a business which is divided at heart is unlikely to be successful.
So, how do we deal with this?
As ever, prevention is better than cure. There is never too early a time to manage people’s expectations and record in writing how a relationship between founders and broader shareholders will work. We will always advise that you seek legal advice sooner rather than later, even if just for guidance about what to prioritise. Common documents we can help advise on and help put in place in the early stages of a company’s life include:
- Shareholders’ or founders’ agreement
- Articles of association
- Share option agreements
- Reverse vesting deeds
We recommend a start-up seeks early legal advice not only because we are lawyers, but because we understand how important it is to get the right advice early and have seen first-hand how not doing this can lead to significant time and energy being spent dealing with an issue that may otherwise have been legislated for in signed agreements. Ensuring everyone is clear on expectations also helps to build trust within an organisation and prevents uncertainty from undermining relationships.
As you consider the above and start to plan how the company will grow and operate, it is important to consider what the ongoing relationship of shareholders and the company will look like, for example:
Ownership
- Who gets what share of the company, and what does someone need to deliver to get this share?
- Is vested ownership of shares subject to active participation?
- How will this active participation be measured?
- Can I incentivise people with something other than equity?
- If I am going to offer equity, should the recipient be given unrestricted shares on Day 1, or shares subject to vesting arrangements or perhaps options over shares exercisable only at exit?
Governance
- How will key decisions be made – at director and also shareholder level? Do certain shareholders have “super” rights?
- What will happen if the shareholders fall out?
- Who will benefit from what salaries and other remuneration packages?
- What happens if an offer is made to buy or invest in the company and not all shareholders agree?
- What is the exit strategy?
Leavers
- What will happen if a shareholder leaves – can they keep their shares, or can the company buy them back?
- Will a leaver be subject to non-competition and non-solicit restrictions for a period after leaving?
Unfortunately, even if you have taken steps to protect your start-up and plan ahead, shareholder disputes still arise and fundamentally, unless there is anything agreed to the contrary, a shareholder can act in pure self-interest.
If a dispute arises for your start-up, your first port of call should be looking at what agreements you do have in place and if any of them apply. However, even if a business finds itself in a position where there is no agreement governing the dispute, then consideration should be given to whether the actions of an unreasonable shareholder can be challenged under their other roles within the Company.
- Directors duties – if someone is behaving in a manner which is prejudicial to the business and they are a director, it may be worth pointing out that as well as a shareholder they are a director and owe fiduciary duties to the Company.
- Employees duties – similarly, if the shareholder is an employee of the company (which they can be even if there is no contract of employment) then as an employee they owe duties to the Company, such as a duty of fidelity.
Conversely, if you are a minority shareholder and you feel you are being treated in a way that is unfair and prejudicial, then you may also have protection under agreements in place with the company, under your other roles with the company or even statute.
Where possible, every effort should be made to try and resolve these disputes quickly. At Ignition Law we are well-practised in using our experience in the world of start-ups and scale-ups to assist with navigating disputes to a successful outcome.
If a dispute ends in the planned exit of a shareholder, we’d suggest considering the following when negotiating:
- Anti-embarrassment clauses – The departing shareholder sells at a price on the basis that they will receive future uplift if the Company turns out to be successful and the shares are sold for a higher value within a prescribed time period
- Are there company assets or intellectual property which need to be transferred?
- Is a waiver of all claims required against the company and other shareholders on exit? If the shareholder is also a director or employee, it may be necessary to extend this waiver of claims and even enter into a settlement agreement
- What price will be applied to any shares? If it’s a minority interest then will a discount be applied to any purchase price?
- Will shares be acquired by other shareholders or will there be a company buyback, and if the latter, does the company have sufficient distributable reserves to do so?
- Does the company have sufficient funds to execute a buyback if that is the agreed approach? Any remaining directors need to take careful account as to whether the company can continue to trade on remaining funds after a company buyback
- Do you need anything else from the shareholder before they leave?
- Are there any tax implications?
There is a lot to think about, but successfully navigating through this, which will be easier if provisions are agreed in advance, will allow your business to move onto the next, much more exciting stage!
Any questions regarding this article, please contact Tammy@ignition.law
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