2 How to read and use this document
3 What is a Founders Agreement?
4 What is a USA (Unanimous Shareholders Agreement)?
4.1 What are the benefits of a USA?
5 How does a USA fit into the overall governance structure?
6 What are the stakeholder expectations?
7 What questions does the founders agreement address?
8 How does the term sheet reflect stakeholder expectations?
8.1 Questions to consider in the term sheet include:
9 How does the USA reflect stakeholder expectations?
9.3 Sale or transfer of shares
9.3.6 Option to purchase/call rights
9.3.7 Option to sell/put right
9.4 Issuing additional stock or options
9.7 Amending the shareholders agreement
1 Purpose of this document
This document is a tool to help the founders and shareholders of a private corporation develop a common understanding of expectations and objectives. This common understanding can then enable lawyers to craft a USA (Unanimous Shareholders Agreement). This tool can be used to both review an existing USA as well as craft a new or revised USA.
The critical action is to document the expectations of the founders and shareholders before starting to spend money on lawyers to develop a USA. Once the expectations are documented, then any issue can be discussed and resolved, leading to a set of common expectations which can guide the lawyers.
This document poses a series of questions, to stimulate thinking and discussion. This is not a comprehensive list of questions. It is up to the founders and shareholders to make decisions. This document does not make recommendation nor does it provide legal advice. Legal advice must be obtained from qualified lawyers. A Strategic Advisor can help you think through your answers to the questions.
2 How to read and use this document
The co-founders and shareholders will be referred to as “stakeholders”.
The document is organized to 6 groups:
- What is a USA and what are the benefits?
- How does the USA fit into the overall governance structure?
- What are the stakeholder expectations?
- What is a founders agreement?
- How does the term sheet reflect stakeholder expectations?
- How does the USA reflect stakeholder expectations?
The point of view of each stakeholder should be documented for each question.
3 What is a USA (Unanimous Shareholders Agreement)?
The Canada Business Corporations Act defines a USA as “…written agreement among all the shareholders of a corporation, or among all the shareholders and one or more persons who are not shareholders, that restricts, in whole or in part, the powers of the directors to manage, or supervise the management of, the business and affairs of the corporation.” All shareholders must sign and be part of the USA
3.1 What are the benefits of a USA?
The USA typically contains provisions in two main areas: decision making and share transfers, which are particularly helpful in the case of deadlocks or an unexpected shift in share ownership as a result, for example, of the bankruptcy or death of a shareholder. A USA is generally recommended whenever there are two or more shareholders in a closely held corporation.
The process of establishing a USA defines expectations and creates provisions which will ideally prevent lengthy, expensive, and potentially damaging disputes in the future.
4 How does a USA fit into the overall governance structure?
Governance is simply the definition of who makes what company decisions and the process for making those decisions.
- The founders agreement may be used before there is any legal entity in order to define key decision making roles.
- The articles of incorporation may limit the actions and decision of stakeholders.
- The by-laws, which are approved by shareholders, limit the decisions and actions of the board of directors and management.
- The board of directors, according to the Canada Business Corporations Act “…shall manage, or supervise the management of, the business and affairs of a corporation.” The board of directors mandate may specify which decisions are reserved for the board
- Board of directors approved policies may constrain the decisions of management and the board. The board of course can approve an exception to any constraints it has placed on itself. The Board of Directors committee mandates may specify which decisions are made by the committee.
- The Delegation of Authority to the CEO may specify that the CEO may make all decisions, subject to board of directors approved policies, and except those decisions specifically reserved for the board or shareholders. The Board of Directors and stakeholders still have the authority to veto any decision made by the CEO as well as make any decision which may have been delegated to the CEO.
- Loans, other financing, and other corporate agreements with third parties may have covenants which in specific situations may provide decision rights to third parties or limit the decision rights of the stakeholders.
- The USA may specify which decisions are reserved for shareholders and which for the board of directors. The USA takes precedence over any by-laws, board of directors decisions, board approved policies, and management decisions. A unanimous shareholders resolution may be able to make any legal decision, regardless of bylaws, existing unanimous shareholders agreement, or other governance documents, except for the articles of incorporation. The company must file with Corporations Canada (if federally incorporated) to amend the articles of incorporation.
- Decision making authority and constraints may also be defined in other documents such as: Share Purchase Agreement or Investor Rights Agreement. Seek to reduce the number of documents which define decision making authority or constraints. Simplicity enables greater common understanding and reduces the costs of creating and maintaining legal documents.
5 What are the stakeholder expectations?
You should document the stakeholder expectations, which may include the following questions. The intent is to identify where there are common expectations as well as disagreements. As the stakeholders review and discuss their expectations, they may revise their expectations.
The stakeholder expectations are the foundation for preparing the founders agreement, term sheet and USA. When issues arise with the founders agreement, term sheet or USA, revisit and revise if necessary, the documented expectations. Do not attempt to come to agreement on expectations by spending large legal fee to revised term sheets and USAs.
In my experience, the agreement on stakeholder expectations may take several months.
- Why does the company exist?
- Why is the stakeholder involved?
- Make a positive impact on society?
- Have a positive impact on stakeholders reputation?
- Make money?
- Some other reason?
- What are the stakeholders’ specific objectives?
- Realize x times return on investment within y years?
- Sell the business within x years?
- Growing the value of the company year over year?
- What are the key milestones?
- What is the scope of the business?
- Nature of the business?
- What the business cannot do?
- What contribution will each stakeholder make?
- Introductions to potential customers?
- Introductions to potential employees?
- Introductions to potential suppliers?
- Expertise relevant to the business?
- Time devoted to the business?
- How will the stakeholder realize financial value from the business?
- Sale of equity?
- Sale of business, followed by cash to shareholders?
- Fees, salary, or other compensation?
- Products and services provided by the business, perhaps at cost?
- Other ways?
6 What is a Founders Agreement?
The founders of a company may have an agreement before the company is incorporated and a shareholders agreement put into place. This agreement may or may not be a legal document signed by the founders. Even if signed, it may only be an intent rather than legally binding on future actions.
6.1 What questions does the founders agreement address?
The following are some of the questions a founders agreement may address.
- What objectives and timelines does each founder have for the startup and for themselves?
- Who gets what percentage of the company?
- Will the percentage depend upon vesting over time and continued involvement in the company?
- What will each founder contribute?
- Number of hours?
- Finding customers?
- Finding capital?
- Creating the product or service?
- How are key decisions made?
- Who will be the CEO?
- Unanimous? Majority? CEO only?
- What will be the founders salaries, if any?
- What if a founder wants to leave? Can the other founders buy the equity? And at what price?
- What happens if a founder becomes disabled or dies?
- What happens if a founder wants to sell the company or kill the company?
- What happens if it takes longer than expected to launch the company?
- Can a founder work on other startups while launching this company?
- What are reasons for removing a founder as an employee?
- What happens if a founder does not fulfill the founders agreement?
- If the business does not succeed, can a founder try again?
- How much of the company are the founders willing to give up for how much capital?
7 How does the term sheet reflect stakeholder expectations?
- Once the stakeholders have a set of shared expectations, with no fatal disagreements, a legal document know as the Term Sheet is prepared. The purpose of the term sheet is to outline the terms by which an investor will make a financial investment in company. The term sheet is not a legally binding document, with the exception of items such as confidentiality.
- There may be a negotiation process around the term sheet.
- Once the term sheet is signed, then the USA can be created (often with more negotiation) as well as the legal documents associated with funding and the other items in the term sheet.
7.1 Questions to consider in the term sheet include:
- What type of securities are being offered to investors? E.g. common stock? Class A preferred?
- What happens to the investors investment in the event the company is liquidated?
- What conversion rights, if any, will the security provide?
- What are the voting rights?
- What must be in the shareholders agreement?
- What will be the information rights?
- What key protections will the investor have?
- What pre-emptive rights will the investor have, to prevent dilution?
- What happens if any shareholder wished to sell?
- How are directors elected?
- Will the be a shareholder representative?
- How do you define “sale of the company”?
- What will be the size of the option pool?
- How many years will the share purchase agreement survive?
- Will there by any key representation and warranty items?
- What will be the founders terms?
- What will the founders transfer to the company e.g. intellectual property?
- Will the founders have an employment agreement?
- What are the terms regarding founders vesting?
- Will the company pay for investors legal fees?
- How long is the term sheet valid for?
- Will the founders be prohibited from soliciting other financing during the time the term sheet is valid?
8 How does the USA reflect stakeholder expectations?
8.1 Generic contents
Some of the generic contents include:
- Is there a table of contents for the shareholders agreement?
- Is there a statement that this is a unanimous shareholders agreement?
- Does the shareholders agreement relieve directors of obligations and liabilities regarding decisions make by the shareholders?
- Does the shareholders agreement prevail over articles of incorporation and by-laws?
- Is the business defined?
- Are the business objectives defined?
- Are there definitions and principles of interpretation?
- List of shareholders and shares owned?
8.2 Decision Making
Which decisions are reserved for shareholders and which for directors? The following illustrates some possible decision. These are neither recommendations nor advice as to who makes the decisions.
- Shareholder meetings
- How many shareholder meetings per year?
- Are there shareholder representatives and can those representatives bind the shareholders?
- What is quorum for shareholder meetings? Does the quorum consider any required representation from each shareholder?
- Do decisions of the shareholder representatives need to be unanimous?
- What decisions are reserved for shareholders?
- Changes to the shareholders agreement?
- Changes to capital?
- Changes to board size?
- Material changes to the business and business objectives?
- Mergers or acquisitions?
- Sale of the company or major assets?
- Going public via IPO or direct listing?
- Major financing?
- Approval of any contracts which limit the decision-making authority of the shareholders?
- Appointment of auditors?
- Appointment, termination, and compensation of CEO?
8.2.2 Board of Directors
- What happens if one of the directors dies or is incapacitated?
- Do specific stakeholders have the right to appoint a certain number of directors?
- Do founders have certain rights to nominate certain number of directors?
- Is the process for appointing board chair defined?
- How is director compensation (if any) set?
- What is the minimum number of yearly board meetings?
- What is the process for calling an emergency board meeting?
- What is board meeting quorum? What quorum requirements exist regarding director(s) nominated by each stakeholder?
- How many directors are required to approve a resolution?
- What are the specific decisions reserved for the board of directors, if any?
- Approval of strategic/business pans and related budgets? If so, what must be in these documents?
- Approval of material modifications to strategic/business plans and budgets?
- Appointment, termination, and compensation of all officers, other than the CEO?
- Capital expenditures?
- Dividends or other return of capital?
- Material accounting or tax policies?
- What committees, if any, of the board exist?
- What are the key responsibilities of each committee?
- How is the composition of each committee determined?
- Will the committees have any decision-making authority?
- What are the minimum number of yearly committee meetings?
8.3 Sale or transfer of shares
- What is the process?
- What are the restrictions?
8.3.1 Forced shareholder exit
- If a shareholder is an individual, what happens if: shareholder dies, is incapacitated, declares bankruptcy, divorces, etc.
- If a shareholder is a company, trust, etc. what happens if: there is a change of control, bankruptcy, change in leadership of the other company, etc.
8.3.2 Shotgun provision
- Is there a shotgun provision? (Usually only for a 50/50 two shareholder situation. Allows shareholder A to buy out shareholder B. After A makes the offer, then shareholder B can buy out shareholder A at the same price.)
8.3.3 Right of first refusal
- Is there a right of first refusal? (This gives a shareholder the option to purchase the shares of another shareholder before they are sold to a third party.)
8.3.4 Tag-a-long or piggyback
- Is there a tag-a-long right? (The minority shareholder has the option to block the sale of the majority shareholders, unless minority can sell at the same terms.)
8.3.5 Drag-along rights
- Are there drag-along rights? (The major shareholder has the option to force the minority shareholders to sell at the same terms)
8.3.6 Option to purchase/call rights
- Does a shareholder have the option to purchase the shares of another shareholder?
- What are the terms and conditions?
8.3.7 Option to sell/put right
- Does a shareholder have the right to force another shareholder to purchase the right holder’s shares?
- What are the terms and conditions?
- If there is a fundamental disagreement among the shareholders, is there an auction process. (Each shareholder would submit sealed bids for the shares in question. The highest bid wins the auction.
8.4 Issuing additional stock or options
- Who makes decisions regarding the size of the stock option pool and issues of stock options?
- Do existing shareholders have pre-emptive rights to purchase new shares issued?
8.5 Dispute resolution
- Is there a dispute resolution process?
- Is there binding arbitration?
- How is the arbitrator selected?
8.6 Information Rights
- What information must the corporation deliver to shareholders by what time?
- Must the corporation provide to shareholders other financial and business information requested by the shareholders?
8.7 Amending the shareholders agreement
- Is unanimous shareholder agreement required to amend the shareholders agreement or some percentage of the shareholders?