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Key issues for a start-up where some founding Shareholders are also Employees
21 Dec 2016 Post by: Steven , Kris

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You have a great idea.  On your own you cannot make it happen.  When you bring in employees to help make the idea work one of the ways to incentivise them (particularly in the lean years at the start) can be to offer them some shareholding stake.  This post will point out three key topics that we think you should think through in advance.

  1. What if things turn to custard?: Things are rosy at the start of a new venture and it can be tempting to think that everything will work out.  A few months or years later it may not be the same situation and someone who was brought in for a specific task as an employee may want out.  Or you may want them out.  If they exit as an employee then should they remain a shareholder?
  2. How can you deal with this?:  It is best to think this through objectively at the start and provide for a clear mechanism in a shareholders’ agreement.  That way there will not be confusion and disagreements later on.  We would typically see that a shareholders’ agreement provide for one of the following scenarios:

    Good leaver:
    Depending on how long they have been involved with the venture, it may be appropriate for the employee to simply end their employment and retain their shareholding.  Situations may just have changed (health issues, partner with job somewhere else etc) but there is often no desire for them to also be forced to give up their shareholding when they stop being an employee.

    Underachieving employee:
    It is possible to build in a description of what individual shareholders who are to be employees will be expected to do in the business.  That way there are some criteria which can be used to determine if they are underachieving.  If they are, then there can be a mechanism to require them to sell their shares back to the Company or to the other Shareholders.  This means they will not be involved in the business either as employee or shareholder going forward.

    Bad leaver:
    This is a situation worse than an underachieving employee and can occur where a person has become disillusioned with their situation.  In this scenario it may be appropriate to build in the ability to repurchase the shares of the bad leaver but also build in a discount for the share price that is paid.
  3. Why is all this so important?: The culture of your new start-up will be critical for it being a success.  One of the most common issues for a start-up can be how you deal with a situation where there is a disgruntled employee.  Without a clear mechanism in place it can be extremely difficult to come to an agreement on the way forward and whether they stay or go, remain as a shareholder or not.  That is why thinking this through in advance is so critical.  As the saying goes, “hope for the best, prepare for the worst.”

We hope this guidance is of use and will trigger some thoughts for you about this important issue.

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