Are you starting an Startup ?

If you are a startup, you want investors to grow your business and there exists an shareholders agreement. The SHA is a document that is signed by all shareholders and effectively manages how to control of the company is split among them.

Usually, the bigger the company the longer the SHA and the harder to understand for mere mortals without a PhD in law. Anything that's written the SHA is subject to negotiation therefore, be careful to consider these important things before you sign.

 When a company raises cash from new investors existing shareholders get diluted meaning their percentage whole of the companies diminish as the new investor receives newly issued shares. So in our case with a new investor coming in at 25%. If you own 40% you lose 10 if you own 20% you lose 5. Well its not true, dilution is not always proportional.

The SHA might include an anti-dilution clause which exempts a certain shell are from dilution completely by simply granting him new shares when a capital race takes place and if the man isn't diluted because of the way percentages work then others must be diluted even further in his stead.

In one famous example is in the movie ‘The Social Network’ the SHA included a clause which granted anti-dilution to all shareholders with only one certain shareholder taking the hit. To prevent this from happening to you always watch out for dilution in your SHA.

The Board of Directors is to a company much like a parliament is to some democracies.

It elects the CEO much like the German Parliament elects the Chancellor and they can influence and or veto decisions made by the CEO .Note that the board is not involved with day-to-day operations and not to be confused with the management or executives of a company.

Even though some of them will usually also be board members. But in general who gets to determine the board members. Much like voters determine who's in Parliament shareholders determine who's in the board and then the case of startups and private companies these are usually the founders, investors and others such as employee, friends and family.

But not every vote bears equal weight. Once again much like in certain democracies.

The number of board seats a shareholder can determine is usually vaguely correlated to the number of shares they hold but also to their standing inside the company and their negotiation skills. For example, in a young private company with five board seats the co-founder and CEO might determine two of them while only holding a 20% stake because see so charismatic and likable in the port to the business while another founder who also owns the same 20% gets to determine none

A big investor who holds 30% determines another two while one early investor with only a 10% stake determines another one. Other even though adding up to a total of twenty percent doesn't speak with one voice and is out of the loop. Once it's agreed who can determine how many board members then that's what's written into the SHA and once it's signed the deal is sealed. So you better pay good attention to the Board of Directors section.

Suppose you invested some money into friends start up at an early stage and now you hold a small stake in it. To lead investor is some famous guy who went all-in on your friends idea and holds a majority stake in the company including a majority of board seats. Things have been going well and one of the big guys shows some interest in the startup. So much so that they want to buy control of the business good news for the big guy the only one they have to talk to is mr. majority over here. He can now exit his controlling stake for a sweet profit over his initial investment and you and the other minority shareholders can go fuck yourselves Right! not so, the tag-along clause puts a big asterisk on that deal it gives the minority stake the right to sell the same portion of their stake at the same price and conditions and if the big guy just wants to buy control but not the whole company then they're buying from everyone equally. So viewer minority shareholder the company be especially sure to have your tag-along rights included before you sign. Now maybe you're one of the big investors and your exit candidate wants to buy not just control but the entire company. You think it's a great deal but those naggy small investors don't agree and tell you we won't sell our shares and you tell them yes you will and they say make us turns out you can thanks to the dragged along clause. The dragged along gives the majority shareholder the right to force minority shareholders to sell their shares that the same conditions as them. So, if you happen to hold a big stake in a small company the dragged along clause will be important to you.

Your startup and your employees need incentives and what is the better way to incentivize them then making them co-owners of the business.

Here you go, now I can pay you half your salary while also making you work harder but where do these shares come from who gave away some of their participation.

The answer to this question brings us full circle back to the first topic dilution. When a capital race takes place it's decided how many shares should be newly created and set aside just to distribute amongst the foot soldiers, the data crunches, the sales guys, the managers.

Where's the catch whenever shares a newly created in one end dilution must occur somewhere on the other side. So if the share option pool is filled up to 10% then all existing shareholders will be diluted by those same 10% of their share but it gets more tricky than that as discussed in one some shareholders might cover themselves against share option pool dilution.

The new investor for example made it a condition to juice investment that he won't take a hit from share option pool dilution in this round. Bad luck for the rest of you, Oh look! the co-founder also negotiated its way out of share option pool dilution because he didn't get any board seats after all. All of this haggling is part of the process which might be slipped by you if you don't know what to look for but in the case of at least five things you now do

Thanks for reading this article.This has become a very time-consuming hobby of mine and your support has just been spectacular.