Shareholders Agreement: Fill & Download for Free

From this month’s issue of Boards & Directors magazine:Startup Boards by David S. RoseAuthor of the NYT best seller, The Startup ChecklistThe Board of Directors of ExxonMobile Corporation includes the CEOs of Xerox, Travelers, Merck and Caterpillar, and the former CEOs of IBM, Nestlé, Pepsi and Johnson & Johnson. In contrast, the Board of Directors of a new startup might consist solely of its founder: a 20-something first-time entrepreneur. Both serve the same purpose, which is to represent the rights and viewpoints of shareholders.A company’s board of directors is elected by the company’s shareholders, so before a startup receives outside funding, the board is “elected” by—and usually consists of—the founders (although for a tiny company with one or two founders, “the board” may exist in name only).​Once a company receives its initial funding, there are now other owners of the company in addition to the founders. Where it gets tricky is that all of a company’s shareholders can voluntarily agree to sign a Shareholders Agreement in which they all agree to cast their votes in a certain way.So for a startup company that has taken in an investment from angel investors or venture capitalists, the Shareholders Agreement might provide that the company will have a board of directors consisting of three people, and, regardless of how many shares anyone has, everyone agrees to vote for one director nominated by the company’s founders, one director nominated by the investors, and one “outside” director that everyone can agree on. So in this case, even though the founder still owns 80% of the company, the investors have an equal voice when it comes to control.​In a larger startup, perhaps after one or two investment rounds have taken place, the board might be expanded to five people, with two directors chosen by the common stock holders (the founders), two by the investors (for example, by the directors of venture capital funds that might have invested in the business, or by the most important angel investor, if any), and one independent director agreed to by everyone.​If, at this point, the company has a non-founder CEO, that position might get a board seat (with one for the founders). And if there’s only one major investor, they may choose to fill one of their two seats with an industry expert.​But typically, the common seats will be filled by the founder(s); the investor seats by the lead angel (for an angel deal) or the venture capital partner and/or an associate (for a venture-led deal); and the independent seat(s) by someone experienced and knowledgeable, and who is acceptable to all parties.There is a saying in the not-for-profit world that board members should be able to deliver one or more of the following: wealth, work, or wisdom. In my experience, those same qualities also apply to the directors of for-profit startups:​Wealth—as in investors who can write checks and help with fundraising in future rounds;​Work—as in directors with specific skills who can be helpful in recruiting, business development, customer introductions, exit analyses, and so on; and finally,​Wisdom—in the form of smart, experienced mentors who can provide sage advice to the CEO from an objective perspective.​In an ideal world, all board members would be able to contribute in all three areas. In the real world, however, one hopes for the best, but settles for the best they can get. This can be challenging for a new startup, because getting one or more great people to voluntarily give of their precious time is often a tall order.When it comes to compensation, it is unheard of for any board members of pre-profitable startups to receive cash salaries or stipends. But while founders, company employees, and representatives of venture capital funds typically receive no compensation for their board service, it is not unusual for outside directors—such as an independent director jointly selected by the founders and investors—to receive stock options (in the range of 0.5% to 2%), typically vesting over two to four years.The edge case is when an angel investor occupies a board seat. There are no hard and fast rules, but typically, if the angel is the primary investor in the round and already has a significant equity stake, there would not be an additional amount allocated for board service. If, on the other hand, the angel only has a small bit of equity, and is on the board representing a larger group of investors, then they might be treated like an independent director, with a point or two of options on a vesting schedule.Sidebar: Ten Startup Board Tips​▪ The CEO and the largest investor should both have seats on the board.▪ Set up a regular schedule for board meetings, four to six per year.▪ Send a full briefing package to all board members several days in advance.▪ Have a standard agenda, distributed in advance and followed firmly.▪ Review Key Performance Indicators, but always save time for discussion.▪ The meeting should be run by the chairman of the board.▪ Votes should almost always be unanimous. If not, that’s a big red flag.▪ The end of each meeting should be an executive session without the CEO.▪ Minutes should include only the names of attendees and actions taken.▪ Draft board minutes should be distributed to all members for review.

To expand on what David and Edmund wrote, generally speaking when you take preference share investment round from sophisticated investors, the articles of association will be redrafted to say that the lead investor is guaranteed a right to a board seat (the "Investor Director") and that certain decisions cannot be approved without the Investor Director specifically being included in the majority vote of the Board. Typical clauses that will require Investor Director approval are (a) approving the annual budget (b) expenditures exceeding $X not contemplated in the budget (c) payment of all dividends (d) approval any process that would lead to a stock issuance and (e) taking on debt over $X unless in the normal course of business. European term sheets can be even harder, including that the Investor Director has a block over (f) the specific granting of options and (g) changing the terms of employment (including compensation) for any employee earning a salary over $X or a direct report to the CEO or the board. Furthermore, the shareholders' agreement will include things like the Preference Shareholders being able to block any share issuances where the shares are pari passu or in preference to their position. Finally, most term sheets will include the concept of non-cumulating dividends being paid to the preference shareholders prior to any dividends being paid to the ordinary shareholders (meaning if the board did decide to declare a dividend, it would have to declare a dividend to the investors before it declared a dividend to the ordinary shareholders).Of course, at the Seed Investment level, investments are these days often done by way of Convertible Loan instead of a priced round, so many of these protections are not in place as in a convertible loan round there are generally no changes to the Articles and no Shareholders' Agreements. However, most Convertible Loan Agreements are of short duration, generally 1 year occasionally 18 months - 2 years. This means that while as a founder you could take out the cash for 1-2 years, thereafter at the very least the investors get back their initial money plus interest, unless you have so bled the company dry that it is effectively bankrupt at the time their loans are due. As an aside, one of the reasons against the yCominator SAFE structure is that it has the potential to turn a convertible loan into a perpetual loan, which negates the checks and balance structure built into convertible loans.Of course, depending on the sophistication of the angel or VC investor, or their lawyers, and depending on the froth of the market, one can still find ways to screw over ones investors. I had a company that I invested in back in 1999 that became very profitable very quickly ($60mm revenue and $12mm ebitda 18 months after founding) that went through some difficult times after the market collapsed in 2000, the CEO single handedly returned it to profitability and then, because of lax drafting from when everyone was piling cash into the company in 1999, was able to find ways to take salaries 2-3x market rates every year (and felt justified in doing so), as well as paying dividends to both the investors and himself annually, with the lion's share going to him because he was the largest investor. He never would have been able to get backing for another company from investors, but he didn't care, and died about 3 years ago very happy and wealthy. So irrespective of the answers above, I am sure if you really wanted to find a way to keep the equity and the upside, and either the market was over-frothed and the investors were over-lazy in their legal reviews (or both), you could probably do so.Two last comments worth mentioning. It is often said in Silicon Valley that failure is a good thing and does not tarnish your ability to raise money for your next company. I believe that is true. But poor ethics and misbehavior will almost certainly prevent you from raising money for your next company. I know lawyers work on gag orders and there are all sorts of compromise agreements to avoid court battles that say "the company will provide a positive reference" or at the least "no disparagement." But I can guarantee you, the word will get out if you mistreat your business partners, co-founders, or capital sources. You may never know exactly where or when the word got out, but it will.Second, the premise that you raised seed money and paid out all net profit to yourself has a fundamental flaw in it - the only reason a VC invests at the seed stage is because he/she believes that venture capital financing will lead that business to a market dominating position that the business could not have achieved without venture capital. What VC would only invest in a seed round without anticipating the need for substantial further funding to become a dominant business? They certainly would not have invested a seed amount (potentially <1% of their fund capital base) on the assumption you would create a business that would turn profitable immediately and provide them a large "multiple" but small "percentage of fund" exit.If you really have a business that can only raise angel money and turn so profitable that you can pay out net profits to yourself, don't raise venture capital in the first place; instead, funding your business with revenue / advances from customers.

Standard company documents (Articles of Association, shareholder agreement, registration documents)Documentation for any assets, IP agreements, if anyEmployment contracts, warrantsBusiness licenses, if anyAny agreements with 3rd parties (partners in value chain)Annual report(S) done by accounting company….