JODY Doyle, Partner at Dommisse Attorneys gives a guide to
the five most important issues every startup team should consider.
“If you’re in the process of starting a new business and
want to do things right, you probably already know that it’s important to have
the necessary 'founding documents' – your memorandum of incorporation and
shareholders’ agreement – in place.
do you know what they should cover?” says Doyle.
Here is her guide to the five most important issues she
believes every startup should consider.
- What is
the relationship between shareholders and funders?
In a well-established company this isn’t an issue: shareholders have no obligations to provide any kind of funding or other
support at all.
But nobody gives away shares in a startup without expecting
something in return. So, what contribution is each shareholder going to make,
and how is that going to be compensated in the long run?
This gets especially complicated in startups because it’s quite
typical for the founding shareholders to put a lot of their own money into the
business, either in cash or in salaries not taken. A common way to handle this
is to specify that loans should always be repaid before dividends are declared.
A more hard-nosed option is to decide that whoever can contribute more funding
gets more of the shares – this would involve a “call option” or a right to
convert your loan into shares. There are other options too, each with different
implications in the long term.
Choose a lawyer who can explain it all clearly
and help you choose the option that works for you.
- What is
the link between shareholding and decision making?
Being a shareholder doesn’t give you any automatic rights to
decide how the company should be run on a day-to-day basis. One common misperception
is that a right to appoint directors effectively affords the appointing
shareholder this control.
However, this is incorrect as any director must act
in the best interests of the company (being the body of shareholders, and not
the shareholders who appointed them), or face sanction in accordance with the
Companies Act, No 71 of 2008, as amended.
So, if you’re a shareholder who wants to maintain a degree
of control over the company, you will want to specify certain “reserved
matters” which place restrictions on the decision making ability of the
If you ever want to bring in a venture capital or angel investor at
any stage (and we haven’t yet met a tech startup that doesn’t) they will
definitely demand some of these rights.
Thinking about these issues right at the start, and drawing up founding
documents that reflect what you’ve agreed on, will put you in a stronger
negotiating position later as well as saving you grief in the short term.
- How do
you want to tailor the provisions of the Companies Act to suit your needs?
The new Companies Act has been designed to accommodate the
needs of a diverse range of companies, from the largest blue chip corporates to
the smallest young startup.
Primarily, it achieves this by way of a range of
default, but “alterable provisions”, which can be adapted in a company’s memorandum of incorporation – but if you want to take advantage of these
provisions, you have to do some work. An off-shelf memorandum of incorporation
won’t cut it.
For example, the default in the act is that a private company
must have a minimum of one director. You can agree to set the minimum higher, but that must be specified in the memorandum of incorporation.
consensus is needed to make any changes to your agreements?
This is the stuff boardroom battles are made of and relates
to amendments to the agreement. They are
always subject to certain requirements (voting thresholds, in the context of a memorandum of incorporation), and - usually - unanimous agreement in the case of shareholders’ agreements.
We’ve seen agreements, for example, which specify that
ordinary shareholders don’t even have to attend shareholders’ meetings in order
for it to be valid.
So if your friendly venture capitalist, to whom you issued
shares with certain extra rights attached, decides to hold an important meeting
when you’re out of town, there’s nothing you can do about it. It’s important to know all the options right
at the start, so you can decide what your position is.
- What will
you do when someone wants to exit?
Three friends decide to start a company together. Two years
later one of them makes a deal to sell his shares to someone else.
allow that? Would you want to insist that if one person exits, the others have
a right to sell their shares to the same buyer as well? What if two people want
to sell and one doesn’t? Can the majority force a sale, or not?
consequences of what you agree at the start can be very big indeed; the advice
of someone who sees it all a few times is indispensable.
On the face of it, company law is very dry stuff – a few
minutes with the Companies Act will make the average entrepreneur’s eyes glaze
over pretty quickly. But the specific dry legal clause you choose could have
very dramatic consequences later on.
Taking some time and spending a bit of
money to get an expert to explain it all to you is an investment worth making.
*Jody Doyle is a partner at Dommisse Attorneys