Last week I watched, live, a promising young start up die because of pesky paperwork and a VC that felt the need to go the distance when it came to covering thy butt. It was ugly and it will be nothing shy of a miracle if the lawsuits don't come flying.
[cue the Dragnet Theme]
The story you are about to read is true, only the names have been changed to protect the innocent. Okay, to protect the stupid, greedy, and confused as well.
Start Up is rocking along with a little service. Has paying customers, solving a problem, but is in expansion mode, running out of credit cards/mortgage to pay the bills. In fact, hosting facility, etc, are all pounding on the door looking for payments.
A VC offers up a term sheet, does due diligence, and decides, yep, we're in, let's go to legals. The terms are negotiated, everybody appears happy, capital is ready to transfer.
VC lawyers offer up the shareholders agreement as one of the documents that needs to get signed off by all the shareholders. No problem. Well, almost no problem. Turns out that when the friends and family round was being done, lots of shares were handed out to lots of people for help. A little code help? Here, have some shares. Dropping a pizza by? Here, have some shares. Some cash? Bless you, here, have some shares. You get the point. All told, 42 shareholders which owned 22% of the company. 42 people spread out over three countries. 42 signatures required. And, as fate would have it 21 missing shareholders. Moved, not returning phone calls, no emails, etc.
The VC refused to close without the signatures and, to make a long (painful) story short, the company died for lack of funding.
There are a few lessons inside of this train wreck but here is the big one I'd like to point out.
Shareholders agreement, minority rights and voting trusts are things you need to learn about before you give out the first share of your company.
The most important thing you can do is create a voting trust/minority shareholders agreement for all these 100 share or 1000 share things you will likely do in exchange for services or cash. Most people that help a start up are generally doing it to help you, to be nice, not looking for the retirement investment. They are taking a bit of a flyer on you. Toward that end, those people are about as passive as you can get. They should have no problem signing up for a structure that basically has them along for the ride. I'm not a lawyer so in non-legal terms you need to have an agreement in place that accomplishes these objectives:
- Prevents you chasing around the globe for shareholder signatures.
- Puts the minority shareholders in a voting trust
- Has a specific agreement that clearly identifies the rights/privileges of the minority shareholders.
To accomplish this, draw up a voting trust for everybody who has less than a certain percentage of share ownership. You can use less than 10% or whatever number but spell it out and ensure the language is clear and reviewed by a qualified lawyer. In some jurisdictions, you can't contract out of certain rights, so ensure you know what you can/can't do with respect to voting, etc, where you form up the company.
Also, ensure that things like shareholders meetings, participation rights, etc, are specifically spelled out in the minority shareholders agreement. With a voting trust of all the minority shareholders in place, you can vote/sign/represent them, you can spell out that notifications for meeting go to the trustee and -as an example- the trustee can waive notice. That for example, makes sure that if you have to call a shareholders meeting you can do it on a moments notices, without a waiting period, etc, etc.
Signature requirements and notification requirements also need to be spelled out so that when you sell the company and some random person with 1000 shares goes missing, the sale doesn't die.
One thing you, as the founder, should consider as a back up or comfort for the VC is an agreement that basically says if there is a problem with a shareholder (like your Uncle Ned), you are responsible for the financial risk. If Uncle Ned screams that he should have been able to buy more shares or whatever, any resulting payments to Ned is your problem. This can sometimes prevent the deal from being held up waiting for a random signature. For some, this will be enough comfort, for others (see above), it won't be.
The point I'm making here, folks, is don't go to the office supply store and buy those fill in the blank shareholder agreements and stock certificates. Make sure when you start, you start with the structure that will allow you to take professional money sometime in the future.
The company you save, may be your own.