Still putting off those founding agreements? Here’s how it can cost you

2012-11-30 00:00

OUR law practice deals with a lot of startups — we love working with innovative, entrepreneurial teams of people. But we also, sadly, get to see some startups implode because their founders put off doing some of the boring-but-critical foundation work like drafting a careful, appropriate founding agreement (including a memorandum of incorporation and/or shareholders’ agreement).

Here’s one example scenario: Everyone starts off very excited about their new business, and the three founders of a startup agree to split the shares equally between them. At this point, after all, the shares are worth nothing.

Six months later, the company lands its first big contract. With the prospect of actual money on the horizon, suddenly those same shares are valuable, and the two partners who’ve sweated blood for six months don’t feel at all happy about sharing the spoils with the third member who has yet to quit his day job.

But he still holds a third of the shares, so he’s fully entitled to his third of dividends.

The founding agreements are particularly important in startups, because a shareholder can’t be passive in a company so small.

If you buy shares in a publicly listed company, not much is expected of you. You can attend annual general meetings if you want, but nobody will insist on it; you are perfectly entitled just to sit back and enjoy your dividends.

In a startup, things don’t work like that. If I give you shares in my company, it will be in return for something valuable. Either you’re providing funding in some way, or you’re contributing your skills and expertise. We have to thrash out exactly what is expected of everyone before we start, and establish some objective criteria for deciding whether each person’s obligations have been met.

This is never a comfortable conversation to have: It’s like trying to cut a cake that hasn’t been baked yet. Once it’s ready, of course, everyone will believe they should get a large slice. To avoid conflict, you need to agree the value of each contribution before you start.

Taken together, the memorandum of incorporation and the shareholders’ agreements are the documents that regulate every aspect of your relationship with the company and your fellow shareholders.

In general, there are no basic legal obligations attached to being a shareholder, so whatever you require of each other must be agreed and contracted. It should include what happens if you don’t meet your obligations, and what happens if you want to sell. What process will you use to value the firm, what will the payment terms be, what happens if there’s no cash to pay you out with?

Spending time on this kind of thing while you’re trying to build a business can feel like a pointless distraction. But if you keep putting it off, it will become an issue at some point. So if you’ve never quite got around to sorting out that memorandum of incorporation and/or shareholders’ agreement — take a deep breath, clear some space in your week and call your lawyer today.

Jody Doyle is a partner at Dommisse Attorneys.

Join the conversation!

24.com encourages commentary submitted via MyNews24. Contributions of 200 words or more will be considered for publication.

We reserve editorial discretion to decide what will be published.
Read our comments policy for guidelines on contributions.

24.com publishes all comments posted on articles provided that they adhere to our Comments Policy. Should you wish to report a comment for editorial review, please do so by clicking the 'Report Comment' button to the right of each comment.

Comment on this story
0 comments
Comments have been closed for this article.

Inside News24

 
/News

Book flights

Compare, Book, Fly

Traffic Alerts
There are new stories on the homepage. Click here to see them.
 
English
Afrikaans
isiZulu

Hello 

Create Profile

Creating your profile will enable you to submit photos and stories to get published on News24.


Please provide a username for your profile page:

This username must be unique, cannot be edited and will be used in the URL to your profile page across the entire 24.com network.

Settings

Location Settings

News24 allows you to edit the display of certain components based on a location. If you wish to personalise the page based on your preferences, please select a location for each component and click "Submit" in order for the changes to take affect.




Facebook Sign-In

Hi News addict,

Join the News24 Community to be involved in breaking the news.

Log in with Facebook to comment and personalise news, weather and listings.