If you missed the BizSpark Australia legal webinar last week, you can now tune in on-demand on Channel9. We also captured all the questions asked in the live Q&A and Daniel Szekely, Associate at Clamenz Lawyers, has answered them for you.
Why should you have a shareholder agreement?
“A shareholder agreement will often be 50+ pages and tackle dozens of key issues. Here are a few of the most critical:
- Set expectations – This is the number one most important reason for a shareholder agreement and possibly any type of agreement. A shareholder agreement will set out in writing what the expectations of each party are and may reduce disputes in relation to issues that might otherwise result in misunderstandings in future.
- Company control and management – Understand the decision making process and who controls the company and ensure you have your say.
- Majority and minority protections – Being a small shareholder with no contractual rights carries material risk as does allowing a 1% shareholder to be on the register without rights over that shareholder such as drag along rights. A shareholder agreement will usually set out these rights.
- Confidentially – Making sure shareholders with access to confidential information keep that information confidential is critical.
- Restraint of trade – One of the most powerful tools to prevent shareholders from ‘abandoning the company’ or being involved in competing businesses is a restraint of trade clause which you will often find in a shareholder agreement.
- Dispute resolution – Manage and settle disputes through a contractual process without costly litigation.”
On a convertible note, what happens when you have an exit rather than raise for next round? Does the convertible note at that stage just becomes a payable loan + interest?
“This is usually dealt with under the contract that relates to the issue of the note and a well drafted convertible note will have a mechanism for dealing with this issue. If it does not, in reality and potential acquirer is likely to require the note to be converted or sold before the exit can occur. This will need to be negotiated with the note holder as, if the noteholder refuses, it may be difficult to proceed with the exit while the note remains on issue. If you think an exit may occur whilst the note is on issue, I suggest inserting a mechanism that forces the note to convert in the event of an exit in the same way it would if there was a capital raising.”
Employees vs Contractors – what’s the difference?
“In summary, an employee works in your business and is part of your business whereas a contractor runs their own business. This distinction is critical and it may have implications for your business in terms of PAYG, superannuation, payroll tax, workers compensation, leave entitlements and other risks and obligations. The ATO, Fair Work and other interested organisations have guidelines that set out when an individual is considered an employee or a contractor. This includes things like your degree of control over the person, hours of work, manner and method of payment, supplying of equipment and other factors that may indicate whether the individual is working in your business or running their own business.
It is important to understand that this is an objective test and whether or not you think the person is a contractor, or have titled them as a contractor, is unlikely to be determinative. You need to look at the whole working arrangement with regard to the various guiding principles established at general law (and summarised in various useful resources online provided by the ATO, Fair Work and others).”
Shark Tank is popularising the idea of start-ups brining on big investors. I often think that the investors on the show ask for a large amount of equity early on for only a nominal amount of money. How should startups approach taking on investment?
“In truth if you valued a lot of the startups on shark tank based on traditional P/L and balance sheet methodology, you would probably find that compared to the valuation, the amount of money offered for the equity was quite generous. This highlights one of the biggest challenges with valuing startups and particularly tech startups that have few or no tangible assets or cash flows.
Understanding the ‘fluid’ nature of start-up valuations on capital raising and the inherent challenges associated is the first step. Any sophisticated investor will know that your startup is, in a traditional sense, worth very little and so coming up with projections or valuations based on unachievable goals, numbers or visions is likely to demonstrate a lack of commercial understanding. Instead, acknowledge the issues associated with valuing your start-up and focus on the actual market forces of the industry and sector in which you operate. This may include the balance (or imbalance) between demand and supply of money, references to market size and recent events, your skills, the frequency and size of related exits, previous offers and the willingness of investors to be involved in your company or other established guiding factors. Try to avoid too much bold speculation when approaching investors, particularly if you cannot support your projections with any trading history.
Finally, keep in mind that your starting offer is the most important. Value your company too high and you will scare investors away. Value it too low and you won’t have a buffer for when investors make a counter offer. Pick a number that you consider to be reasonable, with a small buffer for counter offers and let investors know that most importantly, you would like to open up a dialogue about your business and the valuation. This is when you have your chance to make your pitch, show investors your brilliance and justify a value that probably does not make too much sense accordingly to traditional valuation methodologies.
If you still do not feel confident about the issues associated with valuation when approaching investors, you may consider using third party intermediaries that operate in the startup/capital raising space to help guide these negotiations and get the best possible outcome. Of course, this will always come at a cost that you need to weigh this up.”
Keep an eye out for upcoming webinars. We will be sharing our plans soon.
We look forward to seeing you online again!