Startups often use platforms and standard documents for their corporate set up. We know it’s tempting (and cheap). But BEWARE. We see the same problems over and over again, with founders not getting the support and advice they really need.
LegalEdge’s James Downey and Helen Goldberg share their tips.
- You probably don’t need a full shareholder agreement at the start, in fact it can make things difficult later on if you have a big cap table. But it is vital that key shareholders (founders) have an agreement in place FROM THE START, setting out an agreed framework for dealing with problems before they happen. It’s like a prenup – you hope it won’t be called on – but if someone needs to leave, or you have a serious disagreement, you will need a quick and orderly break-up. If you don’t have a framework in place to agree what someone’s contribution has been and how it should be dealt with quickly and efficiently, you’ll end up having prolonged difficult discussions, which can actually destroy a business. This is why institutional investors will insist on “vesting” and “good/bad leaver” clauses. Have that discussion at the outset with your co-founders, with advice and guidance from someone who knows what they’re doing.
- As institutional investors come on board, they will also insist on protecting their investment by having a say on how the business is run and grown. This is why they require a long list of “investor consents” and “information rights” in an investment agreement, i.e. what do the management team need to tell investors about and what do they need to get consent for. Getting advice on this is crucial, so you can push back on things that could cause problems later on. Yes, investors’ interests SHOULD be aligned with those of the founders. But sometimes they’re not. Particularly bearing in mind the rest of their investment portfolio, tax breaks, etc. They will also insist on “drag along” and “tag along” rights in bespoke Articles of Association. And if they don’t, you should, as they may well be key when an exit deal is on the table.
- Another problem we often see is a question over who owns key intellectual property, so make sure it is transferred into the business from the start. Particularly from founders and anyone else anyone that creates it for you, e.g. developers, designers, etc. Don’t wait for this to be raised as a problem during due diligence. It can slow down or even stop a deal from going ahead.
- You’ll also want to make sure that, if founders/ key staff leave the company, they can’t take key assets with them. So ensure you have robust legally enforceable restrictive covenants and confidentiality obligations in place. Shareholder agreements can provide more flexibility than employment/ service agreements, so longer restrictions are more likely to be enforceable. (But have them in both.) And make sure they are tailored to your business and its circumstances to stand the best chance of enforceability.
Invest in a corporate “health check” early on to make sure your corporate documents work as you think they do (you may be surprised that they don’t). And keep things under review so that when something changes, such as new investors/ key employees joining, your corporate documents stay fit for purpose.
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