150310 ShareholderDoom

Shareholder Doom – and how to avoid it…

It’s easy to start a company. Decide a name and pay your money for registration. Issue the shares and off you go. But what will everyone else think? The shares dictate who actually owns the company so anyone who invests in the company will examine their ownership in detail. There are lots of traps and here are a few simple ones to avoid:

  • Equal Share Holding. Typically co-founders will decide to split the shares equally between them. This can be a recipe for future problems. Consider the following: Who is the decision maker? All co-founders jointly? What happens if one disagrees? Do all the co-founders have complete knowledge of the business so they can make a decision? What happens if the company sells 1% of its shares? That may mean that in times of dispute a shareholder with just 1% of shares decides the direction of the company. Is that the intention?
  • Unregistered Shares. Have the shares that are issued been registered in the company share register, accounts (i.e. paid for) and with ASIC? If only some of these have been done there is ambiguity about the actual ownership of the shares which could be expensive to resolve in the future (from both a legal bills sense and taxation impact for the company and/or individuals).
  • Share valuation. What was the value of the company at the point the shares were sold? What is the justification for this valuation? Something that would look odd is if shares are sold to an employee at $10 today and sold to an investor at $100 tomorrow. The tax man would certainly be interested to know what assets changed in the company to justify the increase in company value by 10x.
  • Enough shares. It is tempting to issue a share to each co-founder when the company is founded. However this leaves little room to manoeuvre in the future. If the founders decide to sell one more share that’s a significant portion of the company. Better to issue a large number of shares in the first instance (e.g. 1000 rather than 1).
  • No Share Holder’s Agreement. A Share Holder’s Agreement dictates how the shares in a company are managed – here are two examples of things that will be covered:
    • How shares are sold. The Agreement will have a procedure for the sale of shares by any shareholder and may contain pre-emption rights. This is where current share holders will have a preferential right to purchase any shares before they are offered to non-share holders.
    • Bad Leaver Provisions. What happens to the shares if two co-founders want the third co-founder to sell their shares but that co-founder doesn’t want to? The Share Holder’s Agreement will have a procedure in place to resolve this problem. Another case: What happens if the employee who received 5% shares in lieu of salary when they started leaves after three months?

Meteorical specialises in Lean Commercialisation – part of this process is to set up a company taking the long term considerations of all parties into consideration. This can reduce the time with the expensive lawyer and save you a lot of headaches later…

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