What legal agreements do startups need for founders, shareholders and investors?
Once you form your startup management team, what kinds of agreements should you enter into to record your legal relationship to the corporation, to each other and to the startup’s other participants? To define the legal relationships, investors, shareholders and founders may require distinctive agreements.
Startup founders and their investors want to document the following relationships with agreements or contracts:
- The terms of engagement by the startup of any persons providing services for or on behalf of the startup (for more information, see Engaging consultants and employees)
- The assignment to the corporation of all relevant intellectual property rights by the persons noted above (for more information, see Engaging consultants and employees)
- The agreement of the shareholders relating to the operation of and transfer of share interests in the startup (discussed below)
Shareholders will document their legal relationship with shareholders agreements
A shareholders agreement is an agreement among the holders of shares in the startup corporation. In general, such agreements address the following matters:
- Election of the board: Shareholders agreements often provide specific shareholders or groups of shareholders with the right to elect directors of the corporation. This ensures that the key founders have adequate representation on the board.
- Special shareholder approvals: Shareholder agreements also usually provide certain groups of shareholders with specific approvals over certain fundamental corporate changes (such as creating new classes of shares or approving the sale of the company).
- Share transfer restrictions: Generally, founders don’t want the shares of their company ending up in the wrong hands. As a result, shareholder agreements restrict the transfer of shares other than in certain limited circumstances.
- Pre-emptive rights: Shareholders agreements often provide investors with a right to acquire their proportional share of any new offering of securities or shares of the company. These rights are called “pre-emptive rights”, and they are typical of most venture-backed and seed financing transactions.
- Drag-along rights: Founders sometimes want the right to require minority shareholders to sell their shares or vote in favour of an acquisition transaction. These are called “drag-along rights”, and again are typical of most venture-backed transactions.
- Reverse vesting provisions: These are important for founders who want their co-founders to“earn” their shares based on the achievement of certain milestones or their continued engagement or employment by the company. If they fail to do so, the shareholder agreement often gives the company or other shareholders the right to repurchase any unearned or unvested shares from defaulting founders, usually for nominal or no cost.
What must founders cover in legal agreements?
Co-founders should keep their initial legal agreements pretty simple, bearing in mind two key numbers:
- 50.1%—the voting threshold for legally controlling the board
- 66.67%—the voting threshold for making any other change to the corporate structure
If founders trust each other, and they collectively hold shares sufficient to satisfy these basic thresholds, they can probably limit their shareholders agreement to a few key elements.
What do founders not need to cover in legal agreements?
Founders generally need not worry about any long-term or estate-planning matters in agreements. Avoid the seventy-page, “everything-but-the-kitchen-sink”-type of agreement and go with something in line with the agreement’s expected lifespan (for most companies, this lifespan lasts until the next round of financing or other significant transaction).
For a sample template of a founder’s agreement, see our article Sample funding documents for Ontario entrepreneurs.
This article was produced by James Smith and Shane MacLean and is made available through the generosity of Labarge Weinstein Professional Corporation.
- Limited partnership agreement: Sample template
- General partnership agreement: Sample template
- Intellectual property (IP) assignment agreement: Sample template for Ontario startups
- Shareholders agreement for startups: Sample template for Ontario startups
- Convertible debentures and early round equity financing