Top Tips For Startups
So, you're a founder of a start up business, you've worked hard to get it off the ground and you have even found investors who are willing to provide the funds you need to grow your business and achieve your goals.
Sounds perfect doesn’t it? However, what you don’t want to do is end up in a situation whereby once the investment round has closed you lose all the rights and control you had before the investment was made. To prevent that from happening, there are certain terms which can be incorporated into the investment documents to help ensure that your rights as a startup founder are protected post-investment.
It goes without saying that the terms of each investment and the documentation containing those terms will usually be negotiated in one way or another before they are signed up to. Although there is no guarantee that investors will be willing to accept some or any of the terms you request as a startup founder, you will need to balance the potential of the investment to transform your business alongside the chances of you losing control, and perhaps even the value in your equity.
With that in mind, this blog aims to set out some of the terms which founders should be looking to secure in order to protect themselves:
Directors are responsible for most of the day to day management of a company, and directors should be able to access all relevant financial and other information. As a founder you will most likely already be a director of the company and this is a right you will want to ensure you retain for so long as you are holding shares in the company. You will want to make sure that the right covers the ability to appoint yourself or someone of your choosing. Including this right will mean that you continue to have influence, and remained fully informed in relation to the business.
In all likelihood, post-investment you will be required to have a service agreement in place with the company (if you haven’t already got one). Included in your service agreement will be a number of restrictive covenants which will apply to you both during your employment and for a certain period of time after you cease to be employed.
These restrictive covenants typically restrict you from working with or being involved in another business which competes with the startup and from poaching clients or employees. Whilst it is entirely usual for an investor to require these terms to be included, as a founder you will obviously want to ensure that they are limited in terms of time, location and business sector, so that you are able to work in another business if you leave (or are forced to leave) earlier than you have anticipated. We therefore recommend thinking seriously about what is realistic, according to your personal circumstances.
It is often the case that employees who hold shares will, upon their employment ceasing, be forced to offer up some or all of their shares (usually initially to the other shareholders, or to the company itself), in accordance with certain provisions in the company’s articles of association (see our related blog, Articles of Association, Shareholders’ Agreements and Investors’ Agreements – what’s the difference?). As a founder, ideally any such provisions would not apply to you at all, but it is increasingly common for them to apply to some degree. If they do apply, then ideally some or all of your shares will “vest” over a certain period of time, ie they will no longer be subject to the provisions, and there will then be less impact should you leave in the future. It may be that your investors expect you to remain active in the business for an agreed period (for example 4 years), and that a quarter of your shares then vest at the end of each year.
Leaver provisions will also specify the price to be paid to a departing founder for their shares in the company. The departing founder will usually be categorised as a “good leaver” or a “bad leaver”, according to the circumstances in which they leave.
The definition of a good leaver is often very limited and sometimes it is only possible to be a good leaver as a result of death or serious illness, but ideally it would also include where you are unfairly dismissed by the company. The definition of bad leaver, in contrast, is often very wide and will generally cover all circumstances, save for where the shareholder is a good leaver.
If the shares are sold, the difference in the price payable in these two circumstances may be very different. The price for good leaver shares is usually linked to a mechanism calculating their “fair value” (ie as if they were sold at arm’s length terms to a third party) and the price payable for bad leaver shares will usually be the total nominal value of the shares (ie the value into which each share is denominated), or the total value which was paid by the original shareholder when they were issued (ie the nominal value, plus any premium).
Leaver provisions may be complex, and we would strongly recommend that you take advice on the drafting of all relevant documentation.
As time goes on and as further investment rounds close, you may find your shareholding in the company diluted which can have an effect on your ability to influence decisions at shareholder level. However, if you are likely to remain as the majority shareholder for a period post -investment, you should ensure that a “drag right” is included in the articles.
In the event that an offer is made to buy the company by a third party purchaser, a drag right will allow the majority shareholder to compel the remaining shareholders to sell their shares to the purchaser, on the same terms as have been offered to him.
All shareholders will be entitled to receive the same price per share for their shareholding and so this does not disadvantage the minority shareholders, but equally it will enable the majority shareholder to proceed with the sale and not miss out on what could be a highly favourable offer.
The above is not an exhaustive list but does give an indication of some of the usual startup founder protections you may expect to find in the investment documentation.
If you require advice or assistance in relation to the drafting and / or negotiation of any investment documentation, please contact a member of our startup investments team who will be happy to help you.
James Fulforth is a Partner and Head of the Corporate and Commercial department. James advises on corporate transactions, including angel, VC and PE investments, mergers and acquisitions, joint ventures, and re-organisations. He is an advisory board member of Angel Academe, the angel investor group, and regularly acts for founders of and those investing in early-stage and startup ventures.
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