Venture process the eyes of a lawyer: management and options

Thank you very much for the positive response to the previous article in the series. This time will focus on what happens after the investment of the transaction on corporate governance in start-UPS and, in particular, on the conditions of the corporate contract. Recall that the cycle written at the end of the meeting, “Investors and entrepreneurs. Learn to negotiate”, organized #tceh and FRÍA. Video and presentation from the event are recommended for viewing.

Illustrations for todays material from there. A startup is a small company that is quickly becoming a big. For several years a successful startup goes through all the challenges of growth. The problems of attracting investment, ongoing management, strategic planning, monetization, optimization. The management of the startup can make a lot of mistakes and learn from them — for investor.

Therefore, the investor monitors his charges startups to avoid critical situations. The office of a startup investor is not interested. Aims and market strategies of start-UPS is too extraordinary to pass it on to hired managers, so the optimal strategy for the investor — not to interfere in the current process, and to participate in key decisions. Only the team that founded the start-up and sore they can achieve success. Therefore, it is for the team and not the technology that puts the investor.

Its task is to improve the quality of the team, and did not meddle in the decision-making process unnecessarily. For this early-stage investors (seed funds, accelerators) invite mentors to their peers, investors later stages include complex terms in corporate contracts. As a result, venture funds do not try to get sverhskorostey package 99%, 75% and even 60% stake in the startup. Indeed, in this case the team will lose motivation, and no miracles of corporate governance will not save the situation. Investors prefer to dispose a relatively small share in the management of the company (25-50%), complementing its veto power and additional authorities on individual issues.

Say, a right to vote on increasing the authorized capital of the company, changing the articles of Association or the shareholder agreement, the election of new members of the Board of Directors. The conditions under which decisions are made in a start-up, established in the corporate contract that shareholders (participants) of a startup investor, founders, and other shareholders enter into. Russian legislation allows to conclude such a Treaty and to the JSC and LLC in addition to the Charter. By the way, FRÍA promises in December to make publicly available detailed template corporate contract. If the founders run the company, from the investors point of view they are no different from corporate employees and should receive a market (in the sense of “relatively small”) salary.

In some situations, the investor may insist on hiring a professional Director — in this case, the founders remain in positions of shareholders and co-owners of a business and profit on a par with other shareholders. Speaking of profit. From operating activities profit start-up normally there is no. Its task is to quickly capture the market, spending invested funds (cash burn). Therefore the payback of start-up is not a priority and some make a profit only after the IPO (Facebook), when appearing small shareholders demand dividends.

On the other hand, if the startup is well monetized, and the money to spend on that, the investor can negotiate with the founders about the distribution of the part of dividends. Shareholders can also earn real money if someone from new investors will redeem a portion of their share (cash out). Investors dont like to pay salaries to the founders of a startup, but always “for” additional motivation for employees. We are talking about optional programs. The transfer of employees of a startups shares under a condition precedent.

About options much has been written, so Ill be brief. In the shares of the companys outstanding option pool — a percentage that is deposited on the stimulation of employees. The company then concludes with “essential” the contract under which the employee worked in the company a certain period of time or reached certain indicators, can get a stake. Option solves several problems: The options from this year on the initiative FRÍA appeared in the Civil code (option offer) and so should be recognized by the Russian courts.

But have many unresolved practical issues. So, at a time the company cannot have more than 10% “no” shares, which include optional pool. If the company has no available shares, and options does not force to implement. Nothing! This problem try to solve legislators the appropriate amendments.

Meanwhile a large company with lawyers to create complex contracts “phantom options” that have greater legal force. In limited liability companies options try not to apply too much this complicates corporate governance. When no one has majority of votes in the company or if the shareholders are fighting each others, there comes a deadlock “deadlock”. Then use pre-defined system output. Most often it is the buyout of one of the parties.

For example, are served sealed proposals on the cost of its share, the facilitator skruvat envelopes and the one who offered the price above buys the others share. Its called “Texas shootout”, there are other ways of conflict resolution. If the company is a startup, the investor is not interested to buy a share in the deadlock. After all, he doesnt need full control, he doesnt want to run the company instead of the founders. In this case, you may use a put option the investor sell their shares back to the founders (of the put option, this will tell in the following parts).

If startup teams do not agree on the put option remains to “butt”. To finish this about the management. The next part is about the disposal of shares and corporate contracts. In comments were asked to describe how these schemes work, LLC, IP and so on, especially because Geektimes did an excellent text on this subject the day before yesterday. I could answer “no way”, as the author did in that article, but, actually, the answer is a little wider.

So about the adaptation of English law to Russian realities (and specifically about the LLC and JSC) will write a separate article when Im done this cycle. In the meantime, look “a Year through the eyes of lawyers” — about what steps were taken by Russian law for the year.


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