Bernat Farrero and Jordi Romero interview Josep Navajo to talk about one of the most important documents when founding a company: the Shareholders’ Agreement.
Josep is a lawyer and CEO of Delvy, a law firm specialized in entrepreneurs especially when they are starting their businesses and helps them in their growth. Josep shares all his knowledge about what establishes regulates and orders this agreement, as well as the usefulness of the clauses it may include.
How does Delvy help entrepreneurs?
It all started when my partner and I met while doing a Master’s in International Business Law. Then we saw an opportunity to work with entrepreneurs and help them found their companies. We started by advising more early-stage startup entrepreneurs and we’ve been doing it for eight years or so. We have always bet on growing with the client, helping them with all kinds of things that they may not have detected yet. We understand startups, their business model, how they work, what they need because we were born as one of them, so to speak. So when they come up with their problems, discussions, concerns, we understand them and try to help them with their legal processes.
What is the ‘shareholders’ agreement’?
Every entrepreneur has a moment when they want to start a company with a friend. And, many times, they think that a shareholders’ agreement is not necessary because they trust each other.
Obviously, when you start a company with someone it’s because you get along well, otherwise you would not set it up. The problem is that you get on well, but maybe you haven’t shared a professional life with that person, you haven’t set up a startup, you haven’t spent 12 hours working with that person. That is when the friction begins to appear. The moment you get along and trust each other is the time to set the foundations of the relationship as partners because at that moment you are aligned at the vision level. That is the best time to do it. It does not make sense that at the time when the positions are divergent, to say that there is no longer a point of union, the partners’ agreement has to be made because they will not be able to sign it. In the ideal case, a partner’s agreement is a document that remains in a drawer and is never looked at. But in practice many times you look at more than people think.
What’s the first step to having such an agreement?
The first point would be to define what the company does, the assets of the company, and who owns them. You have to define the percentage that you have within the company and obviously what your role will be. That is, what is expected of each of the partners who are founding the company. And not only when they found it, but in the medium and long term.
What happens if this is not regulated? What is the risk?
There may be a conflict between the partners. It depends on how the company is structured, if it’s a 50/50 agreement, then the company can be blocked. If you have a majority and you want to take a certain action, then you can carry it out.
A company is generally divided into shares. It is not like an assembly where a person is a vote, but a share is a vote. And participation in an S.L. is a vote. So if there were no regulations at all, the one with 51 percent of the stakes can decide on the absolute future in the majority.
Obviously, it is regulated by the corporate law and by what the company statutes have established, where there are small minority protections. But essentially, whoever has a majority has more “power” within the company’s decisions.
The shareholders’ agreement regulates an agreement between the partners beyond the majority.
It is a fixed unanimous agreement, which is not going to be changed; unless all partners decide that they are going to change it.
Assets have to belong to the company, not to a natural person. What is the next step?
You can make the agreement with very generic roles, which is a bit of a disaster, because in the end in a new company everyone does a bit of everything. Defining roles is better to be able to define objectives. There is usually an annex with the functionalities.
There are many situations. One of the sources of conflict in partner agreements, especially in the initial phases, is with the technological partner that does not measure up, because deliveries or functionalities are delayed. So there is no match. It is difficult enough to build a startup and make it work and grow, to be worried about conflicts with one of the partners.
The problem will come in the next shareholders’ agreement. Imagine if we were partners and, for some reason, I get angry and start making your life impossible. I’m going to try and bother you with the Board, but where I’m really going to bother you is when you are trying to raise a funding round and I decide not to sign the agreement, for example, because I don’t have the obligation to sign the agreement. Usually, people want either to stay with equity and see where the startup goes, or to be compensated for the work they have done. Normally the agreement gives regularity to the permanence, the cliff, the vesting, how it is consolidated. And then the most important thing, the exit of the partner: if it is a good leaver or bad leaver.
What’s the ‘cliff’?
The Cliff is the initial period. If there is a permanence of X years, there’s an agreement on how the shares are consolidated. It can be an annual, quarterly, monthly, daily consolidation, as regulated. A one-year cliff is set, which is a period of permanence, and if you leave or are fired before completing that year, you will be left with nothing. But, from that year on you are consolidating. And from there, if they throw you out in year two and five months, it will be necessary to see what you have consolidated the year two and five months.
Permanence is regulated between the partners. But when you raise a financing round, an external investor comes in and asks for permanence again.
What many entrepreneurs don’t know is that each time a funding round is raised, they reset the timer to zero again and the investors ask for the three or four years of permanence. Because obviously, for the investor, the timer is at zero when they decide to invest. And the company is not worth the same, obviously, with the founding team as without the founding team.
Good-leaver and bad-leaver are clauses that entrepreneurs should pay attention to because they can leave us out of the company and without our shares. What do these clauses mean?
Well, a good-leaver exit would be, for example, to get kicked out of the company for no reason. For you, it is a ‘good leaver’ situation because you haven’t done anything wrong. I mean, you get fired with unfair dismissal, that’s not your fault. For example, the opposite case would be that you’ve been dismissed because you have stolen from the company, that would be a ‘bad leaver’ and it would penalize you. There are some clauses that all venture capital funds usually put in place, but they are always negotiable.
How is the governance of a company regulated from the beginning until the first funding round?
There are two or more decision-making bodies: the General Meeting of Shareholders, which are all the partners of the company, or Administration. The Administration can be a single administrator or a Board of Directors that has several members and votes on decisions by majority.
The shareholders’ agreement limits certain decisions to require the approval of the rest of the partners or certain people. If the entrepreneur negotiates and three investors come in, the strategic thing for the entrepreneur would be not to require the vote of the three, but the vote of the majority of the investors or the vote of one of the three investors, because then it gives the entrepreneur the ability to align with one of the investors and carry out the proposals.
What has to go through the Board?
Well, it depends. In other words, the powers of the CEO are often limited. So they have to go through the Board, if the CEO does not have the powers to do something and we need the power of the council. Or, if the agreement has detailed that the boards have to report what are business KPIs, and so on. At the decision level, approval of the year’s plan, debts, special hires, compensation of the founders’ executive team. Obviously, the board is responsible for the formulation of the annual accounts, the transfer of certain company assets, or the company’s asset license. There is a wide list of subjects. And then on a day-to-day basis, the investor is not one hundred percent involved in the startup either. They go to a counselor every X months.
The sale of your shares to third parties, or from your partners to you, is regulated.
It is regulated by law, and it should be regulated in the shareholders’ agreement.
If the shareholders’ agreement is not regulated, you have a problem because you cannot force a partner to sell their shares, but if you have an agreement, it would normally regulate the clause called the Drag Along, the drag clause that, depends on how you configure it, but if you receive an offer for 100 percent of the company and you have the approval of X percent of the partners and it is an offer greater than X amount, then you can drag the rest of the partners to sell under the same conditions. Everything must be very clear in writing in the agreement. The best case would be that you have a shareholders’ agreement signed by everyone and all the given powers are stated clearly. Initially, you are not going to write a two-page drag along, you probably will when you are in more advanced phases where the clause becomes more complex and it involves penalties.
Economic clauses are scary but are part of fundraising and valuation. Usually, the amount raised is published but not the valuation.
Going to very high ratings in an initial phase can play a trick on you because what it means is that you have to make it even higher the next. If you raise a round to valuation 10 and then you have to lower the valuation 4 no matter how much you have neither anti-dilution nor liquidation preference, the company loses credibility. The valuation is important, the amount you raise is important, but the agreement that you have set up is very important. Obviously I prefer perhaps less money or less valuation and a much less aggressive partner agreement. Because it will give you certain freedoms, it will allow you to better manage the company. If in the end a shareholders’ agreement or a very good valuation is signed, but with some clauses that will take a toll on you in the short term, then better not to do it.
When is it necessary to sign a shareholders’ agreement?
You can do it whenever you want, I recommend to do it as soon as possible. Obviously you have to watch out for risk and resources. You never know, maybe nothing happens to you and you have saved the 1000 euros which is the average price to sign an agreement. But maybe you do have a problem with your partners and the 1000 euros that the agreement costs will become 6000 in negotiations and issues. I recommend that people sign an agreement, even if it’s just to explain the spirit of why they are founding the company together and what they expect from each other. In addition, the shareholders’ agreement must be drafted and agreed upon to measure.
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This post is also available in: Español (Spanish)