How to Navigate Your Startup When Surrounded by Piranhas — The Shareholder Agreement explained for entrepreneurs (part 2/4)
Over the last 6 years I’ve talked with around 50+ entrepreneurs about Shareholder Agreements and I noticed it always led to discussions and they are often misunderstood. So in this series I shine some light over the Shareholder Agreement (SHA); the terms used by investors. Why they are important for the investor, what the consequences are for you, the founder.
The first part can be found here and it is a recommended read before continuing, to get the full picture.
Daily management
The day-to-day operations are executed by the Board. Board means the management board (statutair bestuur) of the Company, which consists of the Directors.
At Holland Startup each company has two Directors, the two co-founders. The Directors shall carry out their activities pursuant to their Management Agreement. Management Agreements means the management agreements between the Company and the Founder Holdcos respectively.
In any given company you can encounter situations in which a director, unfortunately, needs to be replaced, for example in cases of underperformance, wrong behaviour, a lack of experience combined with the inability to learn or simply too little time to learn the new skillset.
This decision would not be taken lightly by the Shareholders. Normally, suspension and dismissal is done by a simple majority of the General Meeting. However, since founders would be unlikely to put their own position up for suspension or dismissal, investors need to structure this differently.
They need the right to suspend a director. This is where the Shareholder Agreement comes in. In a well balanced SHA you will read that the suspension needs to be ratified by the General Meeting, before the director will be dismissed:
Suspension and dismissal
“The investor shall have the right to suspend a Director, provided that the investor shall notify the General Meeting immediately of such suspension.
Following such notification and within 30 days of the suspension, the General Meeting shall discuss the suspension and vote to ratify or undo the suspension (provided that if the suspended Director is also a Shareholder or an affiliate to a Shareholder, the vote of such Shareholder shall be excluded). If no extraordinary meeting is convened within 60 days following the day of the suspension, the investor shall undo the suspension.
In the period between the notification and (a) the appointment of a new Director after dismissal of the suspended Director or (b) undoing of the suspension of the suspended Director (whichever event is applicable), the investor shall be entitled to appoint a pro-tempore commissary to assist the Board or to observe the tasks of the dismissed or suspended Director.
If the suspension is ratified by the General Meeting, the investor shall have the right to dismiss the suspended Director.”
The Entrepreneurs Perspective
You should know that suspending a director, that is also founder, is a tedious situation to be in. Not only because you suspend one of the founders, who after dismissal is still shareholder you need to work with, but also because it can lead to a power play. Suspension also creates some leakage of knowledge in the team. When a co-founder leaves you lose his know-how he has about the business and the industry.
Suspension is really a last resort. Investors will be more than hesitant to take this decision, they would only do so if they really do not see any other alternatives. Suspension and dismissal is more likely to happen in later stage companies. Later stage investors invest in a specific growth plan. They have the tendency to look for leaders that have executed such a plan before.
As the co-founder you are one of the most valuable assets of the company. These clauses would only come into effect in either extreme cases when a co-founder is really not able to do their job or gross misconduct or if the company is at a stage where it has grown beyond your capabilities as a leader.
What happens when a Co-founder leaves a startup?
It is important to keep in mind that investors invest in entrepreneurs, and entrepreneurs need to create value for the Investor. So when founders leave, the investor is left behind and the value creation is under threat.
Therefore, specific added conditions towards co-founders exist, like vesting and good and bad leaver clauses. This all to protect the ones that are left behind, the remaining co-founder, employees and the investor. Some Piranhas believe:
The Only Good Leaver is a Dead Leaver!
When you become an entrepreneur and raised capital from an investor, you ask them to enable your journey, you make a pact to build a company together and create value.
Since founders build the company, and Holland Startup invests in the founders, we need you in the company for at least 5 years. Investors make sure you stay in the company for a set number of years, it is called:
Transfer restrictions
“During a period of 5 years from today, the Founder Holdcos may not transfer any of their Shares (the Commitment Period). After the Commitment Period, insofar as not explicitly stipulated otherwise in this agreement, the rights attached to the Shares held by a Founder Holdco shall be identical to the rights attached to the Shares held by the Investor.”
The Entrepreneurs Perspective
As an entrepreneur you should understand that you are committing to a long term endeavour. If you leave before, then there are consequences regarding what you are entitled to.
Sometimes events occur where you are not able or do not want to continue. In this case we need to protect the company and all its stakeholders. Then the remaining shareholders will buy you out. The price they pay is determined by the reason for resignation (discount) and the length (in relation to the lock-up (5 years) of your employment.
If you leave without fault because you died, are ill, incapacitated (arbeidsongeschikt), or we needed to let you go, you are a good leaver. In all other situations you are a bad leaver. Investors pay you: Market Value of the Leaver Shares, minus 40% (you were dismissed by reasonable grounds), 50% (you broke your commitment period or lost control over your holding company), or even 95% (if you did something illegal like fraud and stealing).
I understand that depending on how I leave the company affects what value I am able to take with me. This also protects me from decisions of my co-founder.
Power of attorney
That you leave is one thing, but to secure the continuity of the company we need to execute the mandatory transfer as quickly as possible. So you hand over a power of attorney to us. So we can instigate the transfer:
Power of attorney
“The Founders, Founder Holdcos and the Company hereby each grant an irrevocable power of attorney, as meant in article 3:74 DCC, governed by Dutch law to the Investor to perform any legal act and/or action and to do all such acts and things that may be necessary or useful in connection with the effectuation of this clause, provided however that the Investor shall only be entitled to exercise such power of attorney if a Founder, a Founder Holdco or the Company does not smoothly cooperate (for example, does not provide the notary with requested info or documents upon 2 requests thereto) in connection with the effectuation of this clause. In addition, each Shareholder agrees and undertakes to perform any legal act and/or action and to do all such acts and things that may be necessary or useful in connection with the effectuation of this clause.”
Conclusion
A co-founder leaving the company is a mournful event, however, having a clear view on the management structure and the system in place for when a co-founder has to leave makes sure you have a grip on the company in extra challenging times. Facilitating a fair discussion between all parties involved.
To get an even deeper understanding of the SHA and its effects, please read the follow up articles: part 3, and part 4.
