Tag Archives: Montreal Startup Lawyer

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.

Non-Compete Clauses – Common Questions

We are often approached with questions about non-compete clauses in the context of employment agreements and independent contractor agreements and asked whether or not the clause is enforceable in Canada or the US. While the enforceability of a non-compete clause is determined on a case-by-case basis, we thought it beneficial to provide an overview of common questions we receive:

  1. Are non-compete clauses enforceable?  In many jurisdictions, yes, if drafted correctly. However, courts are always on the lookout for reasons to invalidate non-compete clauses. Indeed, in some US states, including California, non-compete clauses are effectively unenforceable.  California courts will even invalidate employment agreements from other states if the employee is now working in California for a competitor.  Elsewhere in the US, you typically need a legitimate business interest to ensure an enforceable non-compete clause.  In Canada, courts will ask a similar question of whether the company has a proprietary interest worthy of protection
  2. What interest is worthy of protection? In both the US and Canada, the analysis is similar.  Courts will ask if a company is protecting trade secrets, confidential information, trade connections or goodwill through the non-compete clause.  If a company is simply trying to prevent competition, the non-compete will likely be unenforceable.
  3. What about independent contractor agreements?  It is possible to apply non-compete clauses to independent contractors but there is a much higher likelihood that such a clause is unenforceable. Additionally, the likelihood that a contractor will agree to a non-compete is significantly lower as contractors are working multiple jobs at the same time and signing a non-compete clause may cause them to lose out on work.  Finally, some courts may interpret the non-compete clause as indicating an employer-employee relationship, which may lead to material labor law issues.
  4. What is a reasonable non-compete?  A company cannot have a non-compete that stops an employee from working entirely except in extreme circumstances, which usually involves a large severance package (for example, applied to a CEO).  Typically, a company needs to limit any non-compete clause by length of time, geographic location and type of work prohibited and to tailor these limits very specifically to the work that a company actually does. 
  5. What about a non-solicit or non-disclosure clause  In Canada, and some other jurisdictions, courts will invalidate a non-compete clause if there are other less restrictive means to enforce company goals.  Often a non-solicitation clause or a confidentiality/non-disclosure clause will operate to accomplish the same objective.

By keeping the above in mind, you should be able to avoid the pitfalls of unenforceable non-competes or avoid them entirely through other clauses.

Our Most Popular Posts of 2018

With 2018 coming to a close we’ve decided to look back at our most popular blog posts of 2018.   Interestingly, all of these posts are on the subject of capital raising/financing, which should be of no surprise to anyone who works in the technology sector!  Now, onto our most popular posts from 2018:

1.  Priced Rounds

In our most popular post we discussed the benefits to priced financing rounds, rather than convertible instruments, for early-stage financing rounds.  We also cautioned that some investors prefer convertible instruments and others will reject a priced round valuation but accept the same valuation (or higher) as the cap on a convertible instrument.   At the end of 2019, I still prefer priced rounds for early-stage investments but only if a Common share is on offer.   I am not fond of preferred share priced rounds prior to a company’s Series A financing (I’ve seen this more than normal in 2018) as this is too early a point in a company’s life for such a complex financing structure and the additional restrictions that often follow.

2.  Things Every Startup Should Know Before its First Financing

In the runner-up post, we laid out four things every startup should know before embarking on its first financing: (1) know your investment structure; (2) have your investment documents ready; (3) don’t treat investor interest as commitment; and (4) be realistic in the timeline for closing the investment round.  I’ll add a fifth: know all your outstanding equity obligations and clean them up before starting the round.  Put another way – all those equity offers you wrote yourself can’t be ignored and need to be cleaned up before the first financing begins.

3.  Video Game Profit Sharing Structures

Finally, in third place, was our post detailing three common structures for video game studio profit sharing: (1) draft a profit sharing agreement; (2) create a separate company for each game; or (3) issue shares to profit share participants.  While clients came to us with numerous structures for profit sharing in 2018, all went the profit sharing agreement route due to its flexibility.

That’s it for 2018.  Stop by again in 2019 for more posts on the law of startups and video game studios, from a Canadian and US perspective.

Things Every Startup Should Know Before its First Financing

Startups often email me to assist with a financing expected to close a few days later.  Eager to get the deal going, I ask about deal structure, such as type of investment, investor rights and size of round, only to learn that structure has yet to be determined and no firm commitments have been made by investors.  While there is nothing wrong with these details being TBD, it benefits startups, their investors and legal counsel to fix as many deal terms before expectations of closing take root as until the above is set in stone, there is not deal.

Before beginning your first fundraising round, consider the following:

  1.  Know your structure.  Fixing the structure for your investment round is critical and shows investors that the company is sophisticated.  Options include a priced round, convertible notes and SAFEs.  There’s nothing worse than pitching to an interested investor and being unable to answer questions about the round’s structure.
  2. Have your Documents Ready.  Be ready to close your lead investor quickly if they are ready to move forward with the investment.  While investment documents may be negotiated further, having the documents ready shows professionalism and speeds the transaction toward close.
  3. Don’t treat Interest as Commitment.  Until investors move beyond expressing interest and into reviewing and negotiating deal documents there is little merit to their interest.  In my experience, converting investor interest into investor commitment is much more challenging than expected and you don’t want to plan the company’s direction over the next year based off expressed interest only to find out that you can close 1/2 the amount expected.
  4. Be Realistic in Closing Timeline.  Attempting to close a round in a few days only happens if the above points have been addressed by the company.  Legal counsel can prepare documents as quickly as the client requires but investors won’t move quickly until they know the investment structure and previously received draft documentation.  With this in mind, set a realistic closing timeline.

Closing your first financing is daunting.  By keeping in mind structure, documentation, investor commitments and setting realistic closing time-frames you will put your startup in a better position to successfully close the round.