Category Archives: Shareholders’ Agreements

Founder Leaving the Company

While founders embark on the journey of launching a company with an abundance of optimism it may be the case that their relationship does not last as long as the company, leading to the question of how to handle a founder leaving the company? This situation goes one of two ways: (1) the company and its founders entered into agreements that address this situation and the process set forth in these agreements is followed; or (2) no agreements are in place and the company and founder are left to try and work out a resolution (difficult if the departure was not amicable).

In this post we will detail two agreements to put in place early-on in a company’s life that could ease a founder’s departure:

1. Reverse Vesting Agreement. A reverse vesting agreement subjects a founder’s shares to repurchase by the company if the founder leaves/is fired from the company within a particular period of time. Each time shares “vest”, meaning that a particular period of time has elapsed and a certain number of shares cease to be subject to the company’s repurchase right. Typical terms are described as “4 years with a 1 year cliff”. This means that the agreement lasts for 4 years and that 1/4 of the shares vest after 1 year and are no-longer subject to the company’s repurchase right. After the cliff, shares typically vest in monthly or quarterly instalments for the remaining 3 years. The repurchase price is a nominal amount, typically the amount the founder paid for the shares upon incorporation (ex. $0.00001/share).

BENEFITS: If the founder leaves within the vesting period, the company can exercise its repurchase right and repurchase those unvested shares. This is especially useful if a founder leaves early, such as within the first year and allowing the company to repurchase all the founder’s shares. Without this agreement, a founder could leave the company within the first year yet retain all their shares.

COMMON MISTAKES: (1) Too short of a term, for example 2 year vesting term when the founder is needed for at least 3 years in order to complete the product; and (2) setting the repurchase price too high resulting in shares that are too expensive for an early-stage company to repurchase.

2. Shareholders Agreement. A Shareholders Agreement addresses the relationship among the shareholders and the company and may often contain clauses addressing founders specifically. Relevant to a founder’s departure, the Shareholders Agreement may contain a section permitting the company and/or the shareholders (or maybe the other founders) to repurchase the departing founder’s shares. The Shareholders Agreement would contain a mechanism for valuing the shares and a process for completing the repurchase. Additionally, even if the shares were not purchased or no purchase mechanism exists, it may contain a voting trust serving to transfer the votes held by the founder’s shares to a company designee.

BENEFITS: By including a repurchase mechanism, the Shareholders Agreement can kick-in following expiration of a Reverse Vesting Agreement, providing a way to easily repurchase shares of a departing founder once that agreement has expired. Additionally, the voting trust ensures that the founder receives the financial benefit in the future of any shares they retain but by transferring the votes associated with those shares to a company designee it ensures that only people actively involved in the company can vote on company matters.

COMMON MISTAKES: (1) Drafting the Shareholders Agreement to only apply to initial shareholders and not containing provisions whereby the agreement automatically applies to new shareholders; and (2) not creating a clear process for valuing shares and a process for resolving any dispute over share value.

In summary, if you plan for shareholder problems at the start you will be well equipped should those problems arise in the future. While founders may not want to dwell on a divorce when they are optimistic about the future they will be glad they did if things turn for the worse down the road.

When Non-Voting Shares CAN Vote

I frequently encounter a misconception that non-voting shares in British Columbia companies do not have a right to vote.  Unfortunately, this is not the case as, in certain circumstances, non-voting shares DO have voting rights.

The obvious circumstances where non-voting shareholders can exercise a right to vote are, for example, alterations to company articles that impact rights held by non-voting shareholders or a company’s decision to amalgamate.

The often forgotten voting right held by all shareholders, including non-voting shareholders, is the annual right to vote on whether the company appoints an auditor and, separately, whether the company produces and publishes annual financial statements.  This vote can be made through a consent resolution (by all shareholders) or through a majority vote at the company’s AGM.   Barring a Shareholders’ Agreement or other voting trust that takes control of how each non-voting share votes, your company will need to seek the approval of non-voting shareholders on an annual basis.

When you sell non-voting shares it is important to understand that these non-voting shareholders do have certain, limited, voting rights to exercise in relation to the company, its structure and direction.  Therein, contrary to the mistaken belief of some founders, the non-voting share class is not entirely passive and can, in fact, take a limited active role in the company.

Startup Shareholders’ Agreement: Should I have a Shotgun Clause?

Exercise caution when deciding to insert a shotgun clause into your Shareholders’ Agreement.  Often, for startups, a shotgun clause may do more harm than good.Shotgun2

A shotgun clause forces a shareholder out of the company. By exercising the clause, Shareholder 1 forces Shareholder 2 to either:

    • sell all Shareholder 2’s shares to Shareholder 1 at a set price; or
    • buy all Shareholder 1’s shares at that same price.

those are the only options.  While this might seem an excellent way to remove a founder who is not pulling their weight, there are a number of risks associated with the clause.

  1. A shotgun clause may create a perception that there is conflict within the founding team.  Investors invest in a startup’s technology AND the founding team.  An early-stage startup that loses its team has a high chance of failing and, as such, investors want to ensure that the team stays together to protect their investment.  A shotgun clause is a heavy handed way of dealing with disagreements among shareholders and may cause investors to think that the startup team has underlying disagreements that may result in its breakup.   While an investor could simply ask that the shotgun clause be removed, the negative perception created by the clause may push away investors before investment discussions even begin.
  2. A shotgun clause may create conflict.  The mere existence of a shotgun clause may exacerbate conflict within a startup team as members know that an extreme solution is always available to solve a disagreement.  By its very existence, the shotgun clause may preclude reasoned negotiation.
  3. A shotgun clause may force you out of your company.  Whoever is richest wins with a shotgun clause – if you can’t afford to buy shares, you have to sell.  A shotgun clause could be used by investors to force you out of the startup you founded, given their superior financial means.

If you are seriously considering a shotgun clause in your shareholders’ agreement, ask yourself, “why it is needed?”  If you are not confident in a team member’s commitment then reconsider whether they are truly essential to the company.  Hopefully consideration of a shotgun clause will cause you to consider the makeup of your founding team and, in the long term, create a stronger company.

Solution:  reverse vest all founders’ equity to ensure that key team members remain for as long as needed.