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Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013)

Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013)






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    Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013) Founders' agreement - A critical start for a start-up (Naina Krishnamurthy K Law 251013) Presentation Transcript

    • Founders’ Agreements A Critical Start for a Start-Up By Naina Krishna Murthy Managing Partner Krishnamurthy & Co. Monday, 28th October, 2013
    • Agenda o The three questions on Founders’ Agreement o The constituents of a Founders’ Agreement • • • • • • • Standard Terms Board Constitution Contributions Vesting and Control Transfer Restrictions Intellectual Property Rights and Promoter Covenants Termination and Jurisdiction o Watch Out Issues o Questions?
    • QUICK POLL How many Entrepreneurs in the room believe that a Founders’ Agreement executed orally is legally enforceable?
    • The Three Questions on Founders’ Agreements What is a Founders’ Agreement: A contract between founders/promoters of a business ooutlining mutual understanding and setting out expectations of each party ostreamlining investment and distribution of money and highlighting roles, responsibilities and obligations of each party Why do we need a Founders’ Agreements: o to record understanding in order to avoid any ambiguity in future o to set expectations, align goals and assign responsibilities
    • The Three Questions on Founders’ Agreements oTo provide for contribution, allocation and distribution of resources oTo pre-empt possible hurdles and identify ways to tackle them When to enter into a Founders’ Agreement: oIdeation stage oIncorporation stage oCapitalization stage It is Advisable to enter into a written agreement to avoid ambiguity in enforcing oral contracts. Further, the agreement should ideally be entered into at the incorporation stage since there would be some amount of investment of time and money by then.
    • QUICK POLL Can an investor force a founder to sell his/her shareholding in the start up?
    • The constituents of a Founders’ Agreements oStandard Terms of a Founders’ Agreement • • • • • • • • • • • • Equity Investment and Capital Structure Board Management and Deadlock Shareholders’ Meeting Fresh Issue and Transfer Restrictions Vesting Business, Business Plan, Accounts and Policies Confidentiality, Non-compete and Non-solicit Representation and Warranties Indemnity Termination and Consequences Governing Law and Dispute Resolution Boiler Plates
    • Board Constitution oOptimum Board Structure - a balancing act •What should be the size of the Board/Odd number structures •Will all the founders be on the Board •Who will be the Chairman of the Board and will the Chairman have veto rights •Unanimous Voting Rights • Advisable to have a legal entity in place before money and business ideas are brought to the table • Company is a commonly preferred structure
    • QUICK POLL Does the Indian legal system allow individuals to take an equity stake in a start up by making contributions in kind?
    • Contribution oContribution – Nature and Nurture •Employee or shareholder or both •What will be the form of contribution by a founder – cash or kind •How would you value non cash contribution •How will the shareholding be distributed amongst founders •How much are the founders willing to dilute in the future • • • Minimum shareholding/capitalization requirements under the law Valuation of assets/intangibles important from tax perspective Incase of foreign founders, contribution has to be in cash or against lump-sum payment/royalty
    • QUICK POLL Can an angel investor with 10% shareholding, prevent a start up from taking money from a VC in the next round?
    • Vesting and Control oOwnership / Control - Shareholding Control •Will all shares be allotted upfront or will there be milestones based on which shares are vested •What are the different possible dilution events •What is the extent of dilution •Should a shareholder be given veto rights •Pre-emptive rights •Enforceability • • Control rights available under the law at different levels of shareholding (Discussed in the next slide) Minority shareholders are given protection under law
    • Vesting and Control Shareholding Level of control over Indian Company <10% A derivative action in the name of the shareholder to the Court of Law on behalf of the Company. 10% - 25% Minority protection rights for relief against oppression and mismanagement. 25.01% 49.99% Can block matters requiring a special resolution (75% voting in favour), which include alteration of Charter Documents, amalgamation and mergers, preferential issues of shares, other rights stipulated in the Articles. 50% Can block all resolutions requiring approval of shareholders by ordinary resolution. 50.01% 74.99% Has majority rights and control over matters requiring ordinary resolution (simple majority), which include the appointment of directors, declaration of dividends, appointment of auditors, issue of shares on a rights basis, etc. 75% - 89.99% Has the ability to pass both ordinary and special resolutions. 90.01% Has effectively full control since minority protection is generally available to shareholders holding 10% or more shareholding.
    • Transfer Restrictions o Restrictions on transferability • Should there be a lock-in? • What happens if a founder wants to sell his stake? • Right of First Refusal/Offer • Tag Along Rights • Drag Along Rights • Transfer upon death or termination of Agreement In case of private limited companies, these are contractual rights
    • QUICK POLL How many Founders here think that the ownership of the IP developed by the founder/employee of a start-up, will vest in the start up?
    • Intellectual Property Rights & Promoter Covenants oIntellectual Property Rights • Protection • Ownership oPromoter Covenants • Exceptions • Non Compete Obligations • Compensation (whether cash or past considerations) • Restriction as an employee vs. founder • Non-solicitation
    • Jurisdiction and Termination oJurisdiction and Termination • Jurisdiction of the Founders’ Agreement • Modes of Dispute Resolution • Circumstances for Termination • Consequences of Termination • Asset distribution post Termination • Restrictive Covenants • Winding up proceedings could be time consuming • Enforceability of non-compete restrictions amongst shareholders • Distribution of capital
    • Watch-Out Issues oEnsure that contract is valid and properly executed oExpressly provide for consideration oStamp the contract with applicable stamp duty oProvide for severability of clauses not recognized under Indian laws oIncorporate provisions into Articles of Association In case any party executing is a corporate entity, ensure that the entity has appropriate authority to enter into contract.
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