Can we raise funds and sign a term sheet without a shareholders agreement?

My co-founder refuses to complete our shareholders agreement. He has always tried to avoid conflict. Every time we come to a contentious issue in the agreement, he doesn’t want to discuss it. We can’t resolve key issues. The lawyer hasn’t been able to persuade him that this needs to be done.

We now have firm offers for $750K seed investment and we need to sign the term sheet. Can we raise funds and sign a term sheet without a shareholders agreement?

I should have educated myself about the legal documents

I never paid much attention to the legal work that was done when we formed the company. There was so much detail it was overwhelming. I assumed the lawyer knew what she was doing so I just signed things.

The first problem arose when the Board couldn’t agree on the terms of an employment contact for our new CFO. Eventually we had to vote and it was two in favor and two against. The issue was the options package.  It turned out that we needed a super majority to appoint a director and distribute options.

We only had four directors so there was no way to break the tie. We finally hired an arbitrator. We appointed the CFO, but two Director harbored deep resentment.

The next problem was when our senior sales manager resigned. The Directors did not want him to keep his options, but the incentive scheme granted them to him after 18 months. The Directors wanted to change the scheme but couldn’t make it retrospective.

The next problem was when we needed 95% of all shareholders to approve a new investment. Three small shareholders responsible for 5.2% of the shares refused. We had to buy them out at a premium.

I wish we hadn't issued voting shares to all our employees

We issued share options to everyone who worked for us when the company was 1 year old. We did the same in years two and three. We had over 150 individual shareholders who lived all over the world. We had to make sure we kept track of them because we needed them to vote on company matters and approve the annual report. This was time consuming and we had already lost track of 12 people who held 7% of the shares.

We were approached by a large institutional investor who wanted to buy a majority share of the company. To approve this investment, we needed 95% acceptance from our shareholders. The investor wants to buy out all small shareholders (under 1%).

It took us three months and we had to hire investigators to locate everyone. There was nearly 2% we never found so it was a close vote to approve the investment.

The board member wanted us to buy machines from his company

We need a new machine for the factory. It costs more than $250K. We looked at all the alternatives and decided on the Northeastern-10. As the expenditure was over $200K, it needed Board approval. One member of the Board was associated with a local company that sold a competitor to Northeastern. He asked if we had looked at his machine and we said we had.

He insisted that we buy his company’s machine even though it wasn’t the best for what we want to do. Our shareholder agreement said we needed 80% approval for expenditures of this level. He blocked all approvals.

It takes a unanimous vote of the Board to change the shareholders agreement.

My co-founder benefits from my hard work without doing any himself!!

We co-founded the business and were committed to it, but it didn’t produce enough revenue to support even one of us. We decided to both work part-time on the business until could pay the salary of one person. The other would join when the business could afford it.

It took 18 months for us to get enough volume to support one of us. I quit my job and started working full-time on the business. My co-founder got a promotion, which meant moving to another city and more travel. He was no longer contributing to the business part-time.

Over the next six months, I hardly heard from him and we grew apart. He didn’t really know what was going on with the business and said he couldn’t do both jobs and was going to focus on his career. He wanted to sell his shares but I couldn’t afford them and there wasn’t enough cash in the business to buy them.

I had a real dilemma. The harder I worked and the better the business did, the more he would want for his shares. I tried to get a friend to reason with my co-founder, but he refused to listen. This isn’t fair!!


Our supermajority of 80% made it so that all four directors have to agree

We were drafting the shareholders agreement and people started talking about majority and supermajority votes. I was too embarrassed to ask what they meant and why they mattered. I get intimidated with all the legal stuff and don’t want to slow things down or show my ignorance.

When we needed to raise funds, the agreement said the board of directors could make the decision, but a supermajority was required. Ours was a threshold of 80%. We have four Directors and one refused to vote for the investment because one of the investors had turned him down previously. It was simply bad blood, but there was no way around it for us; we were deadlocked.

The investor wouldn't let me take my loan back

When the business had been in operation for nine months, some customers didn’t pay on time and the business was running short of cash. I knew they would eventually pay, so I loaned the company $10K. I didn’t make any formal documentation because I was going to get the money back at the end of the month.

At the end of the month, we had to order more inventory because sales were growing faster than expected. With my track record, I raised a seed round from friends and family and one outside investor. I wanted to get my loan back because I don’t take a big salary. The independent investor said there was no legal agreement in place and that if I took the money out, he wouldn’t invest.

Who owns the business?

We met at a hackathon, developed a new business application, and registered a company. We did not have money for a lawyer, so we drafted an agreement ourselves, which set out the shareholding. We all signed it.

There was some work done on the app and there was a rough prototype. We didn’t generate any sales so we went our separate ways. One member of the team continued to develop the app and found a test site. With a little more work it was launched and sold through the Apple App Store. Sales began to pick up and eventually reached $200K in the first year.

The shareholders all meet to discuss what to do. Some wanted to take their share of the profits. The developer said he did all the work and was entitled to a larger share of the profits and that the business needed the cash to grow.

The shareholders were split 50-50 and could not reach a decision. The developer said he was quitting and setting up on his own. The others claimed they owned the intellectual property. Each had a different version of what they agreed to do when they started the business.

How did I lose control of my business when it was my idea?

I had a great business idea but knew I could not do it on my own. I found someone to work with on the proposal; her skills complemented mine and we worked well together. We decided to start a business together and that we would each own 50%. Things moved slower than expected, as sometimes happens with a startup. My co-founder then decided that she wanted to concentrate on her full-time job and family. She stopped working on the business and ended up moving to another part of the country for her partner’s job.

I continued to work on the business and brought on someone new as a business partner. We developed a website and started to sell products. We’re doing well and my new partner wants a share of the business, but my original co-founder objects to that. Now she’s not talking to me and my new partner doesn’t want to put in all the work without getting a fair share of equity. This was my idea and now someone who’s not even working on the business is keeping me from going forward. What do I do?

We didn't realize 1% a year would cost us so much down the line

We did not have any money to pay people so we decided to use share options. We offered options that vested over three years to three people. Each would get 1% of the company’s voting shares each year for three years. If they did not complete the year then they got nothing for that year. We solved the problem of getting people to work for us but we did not understand the implications of giving away 9% of the company at the time.

All three people stayed for three years and left during year 4. When they left they took their voting shares. Our shareholders agreement said that it took a super majority to approve issuing new funds. The other shares were distributed as such that people who left held enough shares to block the new fundraising.

We eventually arrived at a compromise but it meant the people who were actively managing the company got a bad deal. It also meant that this situation would recur with future fundraisings unless the Shareholders Agreement was changed. To change the document required the agreement of all shareholders (100%). The founders and future shareholders would be at a disadvantage every time funds were raised.