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February 24, 2007

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awesome advice for startups and easy to follow.

On a related subject, I was told that it's a bad idea to give or sell stock to family or friends, because of a SEC requirement that all shareholders are "qualified investors." The SEC set up these requirements to keep us from scamming little old ladies out of their retirement funds. That makes sense, but it also makes it difficult to know what early-stage startups are actually allowed to do. Could you, or perhaps a lawyer colleague, fill us in on what's permissible?

I realize you're in Canada so the law is totally different for you. I'm not sure if you invest in USA-based companies or purely Canadian companies.

Thanks -- love your blog, very insightful!

Damn I wish you would have been here to stop by PodCamp this weekend. THis is the stuff I need. LoL

Great article... would love to see sample agreement(s). Can you post a link for us? Thanks!

-chrisco
http://www.buzzpal.com

I almost hit a similar problem with a software deal where we decided to reduce complications and legal cost to handle most of the publishers changes first (not all of them, we were still consulting with the lawyers), and then came in at the end with some minor changes.
It came very close to being a deal breaker because the publisher had dragged things out over so long with their side of it, that the time to make the changes we wanted hadn't been factored into the schedule.
I think in future deals I might lay out as much as possible to start, but it worries me that if you show all your cards straight off, you can destroy any chance of a deal too early, or lose some leverage.

Great advice; I would add that if you're a startup and already got yourself entangled in equity/investor complications, be sure to see a lawyer about rolling everyone up into an LLC (or otherwise addressing the issues) before you try to raise venture capital.

This particular story is surprising. When considering an investment that has passed the initial hurdle and is worth a closer look, one of the first things I ask about is the existing investors: who they are, what are the terms, what's the cap table, etc. It's unusual to run into a surprise like that late in the process.

One way to keep from messing up the cap table is to convince people to accept option grants rather than shares.

Option grants don't carry any voting privileges, and thus don't require the usual last second signature chasing that shareholders do.

As a side note, even in a deal with all professional investors, the probability that all your investors are in the country at any given time, can be low. Best to give your investors plenty of warning!

I'm not sure I understand how a tiny minority could kill a deal like that?

PWB,
If the VC wants 100% compliance with respect to signatures on a shareholders agreement and one person holds out or isn't available, the deal can die.

@howard - you might want to take a look at this article in Inc. - seems to be a pretty good summary of the us rules...

http://www.inc.com/articles/1999/11/15743.html

@pwb and rick - sometimes the reason for this is because the VC wants a "unanimous shareholder agreement". as the name implies, it must be signed by all shareholders. ontario and canadian corporate law gives such agreements special status - e.g. transferees of shares don't actually need to sign them to be bound by them - and a bunch of other things.

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