The Importance of Vesting and Shareholder Agreements

Thoughts from Mike Kirkup, Director of Velocity.

One of the most common problems we run into at Velocity when a company breaks up is the stunning realization that a shareholders agreement was never put in place between the founders. It is only then that the founder realizes the value that document provides and how difficult it will be to recover. I think it is important that we understand why founders are not getting this document finished and look at possible suggestions for how to improve it.

There are a number of reasons why founders skip this step. Here are the most common from my experience.

• Not required to operate. The most common is that no one ever requires a shareholder agreement to be put in place. For each company getting started they make the decision early on that they want to incorporate and the bank will force the corporation to be established before setting up an account. No participant in the operational chain (lawyers, bankers, accountants, insurance, etc) will enforce that a shareholder agreement is in place.
• Cost. Legal partners will charge a fee (usually a flat fee) for the shareholders agreement above and beyond the cost for incorporation.
• Too busy. As a founder of an early stage startup I know how many things you have to do when getting a company off the ground. It is easy to justify pushing it to the back burner thinking that it won’t matter unless you can turn this company into something valuable first.
• Confusing. For many first time founders the difference between the corporation (and its accompanying articles) and the shareholder agreement are unclear. There are provisions in the articles that sound like controls for the shareholders but don’t actually solve any of the major issues when a founder decides to leave.
• Best friends. This usually occurs with founders who cannot imagine fighting enough to break up. It is perhaps the most difficult scenario because the founders feel betrayed and are very emotional about a break up.

We have recently made some changes at Velocity in the hopes that we can reduce the number of companies who run into this problem.

• Provide a template. While a template legal agreement is not the best option, it does provide founders who are concerned about cost with an effective option to put in place a shareholder agreement.
• The Velocity Fund requires all companies who win to provide a signed shareholder agreement, signed IP assignment and incorporation documents before they receive the funding.
• Discuss the risks and benefits. So many startups hide their problems, including founder fights, such that new entrepreneurs don’t hear about the horror stories associated with a break up until it is too late. We need to be more transparent and open about these challenges so new entrepreneurs know from the beginning to put these protection mechanisms in place.

I would love to hear other suggestions on how to improve the number of founders of get these documents in place.