Start Up #4 - Top 5 things to look for in your Shareholders Agreement
Everyone that has ever talked to a lawyer about starting a company immediately gets the following advice: "Man, incorporate the company and sign a shareholders agreement."
Incorporating the Company is a step needed for may reason that will not be the topic of this post, but the shareholders agreement is, to me, at least as important whenever you start looking for financing.
The Shareholders Agreement regulates the rights and obligations of all the shareholders of the company, which is, basically, who decides things and how the company is run after the investors come in.
So what are the 5 most important things that should be included in the Shareholders Agreement?
1. Voting rights
Regulating the decision-making process is key to success. Whether you are the entrepreneur or an investor, it is very important to have clarity on who gets to decide what. List the topics that are going to be decided by the board, those that will be decided by a majority of shareholders and those that will need a supermajority of the shareholders. Transparency is fundamental to good functioning.
A Drag-Along means that if a shareholder has a buyer for more than x% of the company, he can force the other shareholders to sell. The key here is to make the drag only applicable if the sale is beneficial for the rest of shareholders.
The Tag-Along means that if there is a sale of more than x% of the company, other shareholders have the right to include their shares in that sale.
3. Liquidation preference
Equity investment is a risky business. Consequently, investors normally demand that in case of liquidation of the company, they have preference over the founders on the proceeds of such liquidation, normally up to the amount of their investment. Later investors will demand preference over prior investors. The rationale here is that they have paid a higher "entry" prize to the company. So in case the company get liquidated, later investors will see their investment returned first, then earlier investors and finally the founders and persons with vested shares.
4. Transfer restrictions
This provision normally goes in two ways. Investors are normally betting their investment in the founder and its team, so they want to avoid that such key individuals sell their participation in the company. If they want to do so, it would normally require approval of a supermajority of shareholders.
On the other side, founders are accepting investors normally for who they are and what can they bring to the company, so they would want to put certain restrictions to the transfer of their shares to third parties, specially competitors or other non-reputable investors.
5. Pre-emptive rights
Normally investment rounds are leaded by a main investors that will get an important equity stake in the company to hold some kind of "control" (although this word is very problematic in these instances). Thus, if the company is rising more money, their stake can be diluted and they lose that "control".
Under a pre-emptive right clause, the company needs to offer its shareholders the option to purchase such amount of shares of the new issuance necessary for them not to lose its participation stake in the company.
Do you think there are other clauses more important than these? Let me know and we can discuss!