Interesting post by Rick Segal on how a financing deal died mid-stream due to paperwork. The nub:
Last week I watched, live, a promising young start up die because of pesky paperwork and a VC that felt the need to go the distance when it came to covering thy butt. It was ugly and it will be nothing shy of a miracle if the lawsuits don’t come flying.
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A VC offers up a term sheet, does due diligence, and decides, yep, we’re in, let’s go to legals. The terms are negotiated, everybody appears happy, capital is ready to transfer.
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VC lawyers offer up the shareholders agreement as one of the documents that needs to get signed off by all the shareholders. No problem. Well, almost no problem.
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All told, 42 shareholders which owned 22% of the company. 42 people spread out over three countries. 42 signatures required. And, as fate would have it 21 missing shareholders. Moved, not returning phone calls, no emails, etc.
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The VC refused to close without the signatures and, to make a long (painful) story short, the company died for lack of funding.
Ouch. Rick suggests setting up a voting trust agreement as one way to avoid running into this issue. That’s definitely a good idea. Another would be to avoid, as much as possible, handing out shares to folks. Many entrepreneurs seem to think of their stock as an easy or cheap way to pay people. That’s only true if your company turns out to be worthless. If it doesn’t, then you can rest assured it won’t be as cheap as you thought.
Think of this way – every time you give someone shares, you are also giving them a little stake in your company and some ability to decide what your company does. So think of shares like bits of your body – before you give away your pinkie, or foot, think about what you are getting in return, and whether its really worth it. And keep very close track of it – before you know it, you might be missing a leg.
And I know this sounds a bit self-serving (at least for my profession) but please, please, please spend just a few minutes talking to a lawyer before you ever give away shares, options to buy shares, or even promise anyone that you’ll give them shares. It may save you a world of trouble later on, as Rick’s story quite clearly illustrates….
