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wherefore art thou, shareholders agreement?

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Most of you have already seen the news about eBay‘s claim again Craigslist reported in Wired and other places. Apparently, eBay is concerned about some action that the Craigslist folks took that diluted eBay’s holdings. Which left me scratching my head a bit, given the little I know about Craigslist, which is that I found it surprising that they would have sought financing (as I couldn’t see why they would want or need it given Craigslist particular approach to its site). However the Wired article explained:

EBay, the world’s largest online auctioneer, was an unsolicited suitor to quirky Craigslist in 2004. An unnamed former Craigslist shareholder sought out eBay and sealed a deal whose financial terms were never disclosed.

Ouch. Presumably, the folks at Craigslist either did not have that shareholder under a shareholders agreement, or they did, but it did not have provisions that would, for example, allow for the right to repurchase shares in certain situations, such as when the shareholder is thinking of selling to someone else, who might, for example, be a competitor, or become a competitor.

Which is why the first piece of advice I give to startups and other early stage companies is that they should be very, very, very careful when it comes to issuing stock or options. Its great that companies want employees and others to share in their prosperity as they grow, but very often what is overlooked is that shares (or stock as those Yanks call it) in addition to providing an economic benefit as they appreciate, also provides for a whole host of rights that you may or may not necessarily want to give out. And which don’t require a majority to exercise (but which can still be a royal pain to deal with), as eBay’s claim illustrates (I should emphasize that I’m not commenting on whether or not eBay’s claim has merit, but rather the circumstances that allowed it to happen in the first place).

Shareholders, even small shareholders, have the potential to cause a lot of difficuties for companies (particular smaller companies) through not only their voting rights, but also statutory rights, such as claims of oppression or the ability to require a company to be audited. For those considering option plans or share ownership plans, its usually a good idea to investigate alternative but equivalent forms of compensation (profit sharing, phantom stock) before going with option or share plans. And if even if you do decide on options or shares, please, please, please get a shareholders agreement in place – trust me, you won’t regret it.

Shares and How Not to Give Them Away

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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….