How to Control and Protect Your Equity
Without fighting with your founders

Everyone gets excited when all the founders form their new company and get their equity percentages figured out. However, it is crucial to take the opportunity, when all the founders love each other and share a common vision for the business, to agree on terms which define what happens when a founder goes bankrupt, harms the company, gets divorced, or unexpectedly dies. This isn’t the most popular topic since no one likes to plan for “what ifs” that are always worst-case scenario, but this is super important.

If you are using a corporation, you need to make sure each shareholder adopts a Shareholder Buy-Sell Agreement. If you are using an LLC, you need to make sure the operating agreement spells out what happens when one of these unfortunate scenarios come up. The last thing each founder wants to experience is being forced to share voting power and profits with a bankruptcy trustee or the crazy, soon-to-be ex-spouse of your best bud co-founder. You can take simple steps to avoiding these major distractions and keeping the company’s equity under control when life throws your team a curveball.

 

How do you know what provisions to include and how to draft them in a neutral way that is fair to all the founders?

As mentioned above, be thoughtful about theses common provisions at the start of the formation. These provisions may include:

•     •   Bankruptcy
•     •   Divorce
•     •   Death

•     •   Disability (mental or physical)
•     •   Unexpected or unauthorized gifts of equity to family members
•     •   External Bad Acts – Founder is arrested
•     •   Internal harmful acts towards the company
•     •   Employment Terminations (Voluntary or for cause)
•     •   Early Retirement

    •   and more…

Each of these provisions should have its own set of mechanics to properly address each situation. While this list of events may be relatively simple or routine, each company will have its own preference on approaching the situation. These approaches may vary based on the event or the shareholder affected by it. At the lowest level, either the company purchases the equity or the remaining Shareholders or members do. Make sure to define each of these situations or events clearly. For example, what level of disability would render a founder incapacitated, thus triggering a purchase event.

 

Pricing and Valuation Methods?

This plan should also account for the price paid for the equity or how to value it if the founder can’t agree in the heat of the moment. Also important is how the purchase may be funded or financed? Many times, a closely held business won’t have the necessary cash to write a check to cash out another founder? Also, what happens if the exiting founder harmed the company? Do they get a flat fee? A low value? Each of these situations also have various tax implications.

 

How to start the conversation?

First, the best strategy is to blame these planning sessions on your attorney. Don’t worry we can take the heat. Following proper guidelines and planning checklists will save hours of frustration, and stressful, sleepless nights. At the onset of forming your company sit down with all the founders and discuss what scenarios should be included. A roadmap is only needed when you’re lost. Similarly, having the Buy-Sell agreement or artfully drafted operating agreement will prove to be a valuable investment of time and energy when you can seem to negotiate in the midst of a corporate meltdown between founders.

Second, carefully structured agreements can take a complex, emotional process to a suddenly streamlined and mechanical procedure. The remaining parties can get back to operating the business, with peace of mind that this founder transition is settled. Shareholder agreements are among the most common, and most critical, documents that are in a closely held company’s files. Briefcase’s attorneys have already anticipated this important need and have your tools available to make sure your company’s equity is controlled and protected when one of your co-founders experiences a major life change. Sign up at www.thebriefcase.co to access dozens of essential contracts that help protect your business.