Please help me!

[JohnnyW]

I am about to join a young internet start-up as a co-founder. The company has been going for around two years and during the last round of investment, was valued at £500,000. Since then, industry advisors have come on board, adding further value to the company. We plan to sell the site ASAP (the current estimate is 18 months) and, as such, I will be living off of my savings and not drawing a salary.

I trust the guys involved, and I believe that together we have enough knowledge and skill to bring the site to fruition.

Coming on at this late stage they have offered me 4% of the company, which I am happy with. We are currently trying to sort out a co-founder contract, however, and we've hit some difficulties.

Here is the contract as it currently stands. Party D is me, Party A and B are the two co-founders and Party C is the company.

THIS AGREEMENT IS TO CONFIRM THAT PARTY D IS ENTITLED TO ACQUIRE 40 OF THE COMPANY'S ORDINARY SHARES. THIS SHAREHOLDING REPRESENTS 4% OF THE COMPANY’S CURRENT ISSUED SHARE CAPITAL AT THE DATE OF THIS AGREEMENT. SUCH SHARES SHALL NOT BE DEEMED TO HAVE BECOME VESTED SHARES UNTIL THE CONDITIONS OF AN ACQUISITION AGREEMENT HAVE BEEN FULFILLED IN THE PROCESS OF THE COMPANY BEING ACQUIRED BY A THIRD PARTY, SUBJECT ALSO TO THE FULFILMENT OF CONDITIONS 5, 6, 7, 8 AND 9 LISTED BELOW. SHOULD PARTY D BREACH CONDITIONS 5, 6, 7, 8 OR 9, THEN THE ORDINARY SHARES SHALL BE DEEMED TO HAVE BEEN CONVERTED TO DEFERRED SHARES AND SHALL BE AUTOMATICALLY RE-POSSESSED BY PARTIES A & B AT NO COST TO THESE PARTIES. FOLLOWING VESTING OF THE SHARES, ALL RESTRICTIONS UPON SHARE DEALINGS OUTLINED BELOW SHALL CEASE TO APPLY AND THIS AGREEMENT IS THEN DEEMED TO HAVE BEEN TERMINATED.

1. Working Commitment: Party D will be expected to commit to equal full-time working involvement as Parties A and B, until the acquisition of The Company. These working hours will be 0800 – 1900, Monday, Tuesday, Wednesday, Thursday and Friday, with a 1 hour break for lunch on each of these days, plus an additional 5 hours of work committed to the Company every week, to be performed at each individual Party's choosing during that week. Changes to the working hours of Parties A, B or D must be agreed upon by Parties A, B, C and D.

This additional 5 hours, together with the aforementioned expected working hours, until the acquisition of the company, shall be referred to in the remainder of this Agreement as the "Initially Agreed Involvement". The Initially Agreed Involvement amounts to 55 working hours per week, as lunch break is not deemed to be included.

Party D shall undergo the Initially Agreed Involvement working hours with the understanding that Party A and Party B shall also be committed to the Initially Agreed Involvement working hours. A breach of these hours by any Party shall be discussed by Parties A, B and D in order that a mutually satisfactory solution be reached between all parties. It is understood that this condition is put in place to define the working hours of the Initially Agreed Involvement with the aim of reducing potential working tensions between Parties A, B and D.

2. Termination:

"Devoted Time" is defined as the total number of hours committed by Party D to the Company from the date of this agreement until the date of acquisition of the Company by a third party. This shall be calculated as the Initially Agreed Involvement of 55 hours per week multiplied by the number of weeks from the date of this agreement until the working involvement of Party D is terminated or reduced, added to the total hours devoted by Party D to the Company at any subsequently reduced involvement level.

"Total Possible Time" is defined as the result of multiplying the Initially Agreed Involvement of 55 hours per week by the number of weeks from the date of this agreement until the date of acquisition of the Company by a third party.

Party C and Party D reserve the right to independently terminate or reduce the working involvement of Party D in The Company. In such circumstances, Party D's resulting shareholding shall be recalculated at the time of the acquisition of the Company, by multiplying Party D's initially agreed shareholding of 40 Ordinary Unvested Shares by the Devoted Time, divided by the Total Possible Time. The amount by which the recalculated shareholding is less than initially agreed shareholding ("The Remaining Shareholding") shall be deemed to have been converted to deferred shares and repossessed by Party A & Party B, at no cost to these parties.

3. Dividend Issues:

"Devoted Time Until Issue" is defined as the total number of hours committed by Party D to the Company from the date of this agreement until the date of dividend issue. This shall be calculated as the Initially Agreed Involvement of 55 hours per week multiplied by the number of weeks from the date of this agreement until the working involvement of Party D is terminated or reduced, added to the total hours devoted by Party D to the Company at any subsequently reduced involvement level.

"Total Possible Time Until Issue" is defined as the result of multiplying the Initially Agreed Involvement of 55 hours per week by the number of weeks from the date of this agreement until the date of dividend issue.

Party D's dividend shall be calculated at the time of dividend issue by the Company, by multiplying the dividend which would have been issued to Party D with the agreed initial shareholding of 40 shares, by the Devoted Time Until Issue, divided by the Total Possible Time Until Issue.

4. Share Issue: If Party C deems that it is in the best interest of the Company to issue new shares to accommodate additional cofounders, advisors or new external investment after 01/04/2008 then Party D shall agree to its shareholding (as an overall percentage of the Company) being reduced in the same proportion to the shareholdings of Party A & Party B.

5. Tie-in Conditions: If the terms of a partnership or acquisition agreement, entered into by Parties A, B and C with a third party, require the working involvement of Party D in the Company over a finite and specified period after the date of the partnership or acquisition agreement, then Party D is required to fulfil its working obligations, as set out in the aforementioned partnership or acquisition conditions.

6. Tag-Along Rights: If Party A and Party B are selling a proportion of their shareholding in the Company as part of a partnership or acquisition process, Party D may insist that an equal proportion of its shareholding are to be sold to the acquiror at the same share purchase price in order for the partnership or acquisition to proceed.

7. Drag-Along Rights: If Party A and Party B are selling a proportion of their shareholding in the Company as part of a partnership or acquisition process, Party D is required to sell an equal proportion of its shareholding in the Company to the acquiror at the same share purchase price, should such sale by Party D become a part of the acquisition conditions.

8. Competition: Party D is not permitted to be involved in any companies deemed by Party A and Party B to be in competition with the Company for a period of 4 months from the date upon which written confirmation of Party D’s termination of involvement in the company is received by Party D.
Party D is also not permitted to be involved in any companies which make use of any intellectual property belonging to Party C extended to, but not limited to the artwork, source code or research material, without the prior written consent of Party A, Party B and Party C.

9. Share Sale: Party D is not permitted to sell or agree to sell any unvested shareholding in the Company without the prior written consent of Party C.

The current sticking point is Condition 5. I feel that I'm leaving myself rather vulnerable to the whims of Party A and B if I, for whatever unknown reason, leave during a "golden handcuffs" period; Potentially leaving me with no shares whatsoever if they decide to do so.

I, of course, trust the two co-founders and I have been assured that there's no way that they would take all of my shares unless something pretty amazingly terrible happened during that period, but that they feel some sort of enforcable tie-in is needed. I understand the need for this, however I feel the way the contract is worded leaves me very open ("SHOULD PARTY D BREACH CONDITIONS 5, 6, 7, 8 OR 9, THEN THE ORDINARY SHARES SHALL BE DEEMED TO HAVE BEEN CONVERTED TO DEFERRED SHARES").

Who knows what will happen in the future, and I feel as though I need to protect my investment in the company as much as possible.

Does anyone have any thoughts or suggestions on the issue raised, or on the contract as a whole?

Any advice would be greatfully recieved. I'm new at this and am trying to do the best I can.

Thanks a lot.

 

[Alexander]

You are correct.
I would suggest that you get the contract rewritten.
It should be totally accepted by all parties. I feel that if these are guys you trust then they will have no drama with you changing what is a pretty restrictive covenant.
Alex

 

[Antonia @limeone.com]

The whole of the contract requires review as there are other less obvious matters which require clarification to protect your position. I agree with the above, a few adjustments should not be a deal breaker on this one. Happy to advise further if you email us.

 

[HAZEL B]

As well as the contract advice I suggest you get an independant accountant to look at the latest company accounts and the projections on which they are basing their figures. Eighteen months of unpaid work is a big investment on your part, you have a lot to lose if their figures are over optimistic.

 

[JohnnyW]

Thanks for your help. Thankfully we've altered the contract and come to a more amicable agreement. I just hope it covers all possible outcomes!

Thanks a lot for your help!

 

[i.m.]

I would be a bit bothered about clause 4.

BR

 

[JohnnyW]

Really? Why?

 

[i.m.]

because it appears C can effectively dilute the shares to nothing

 

[yorkshirejames]

Clause 1 is effectively illegal as it obliges you to work 55 hours per week and does not give you the opportunity to enforce your 48-hour working week entitlement. Something to bear in mind if this deal all goes belly-up.

 

[JohnnyW]

Clause 4 isn't so much of an issue, as it would mean that the two other co-founders would have their proportions reduced, too. Thankfully the contract has been re-worked to:

THIS AGREEMENT IS TO CONFIRM THAT, IN CONSIDERATION OF ONE POUND STERLING (£1) PAYABLE UPON EXECUTION OF THIS AGREEMENT AND OF PARTY D’S CONTINUING FULFILMENT OF HIS OBLIGATIONS HEREUNDER, PARTY D IS ENTITLED TO ACQUIRE 40 OF THE COMPANY'S ORDINARY SHARES (THE “INITIALLY AGREED SHAREHOLDING”). THIS SHAREHOLDING REPRESENTS 4% OF THE COMPANY’S CURRENT ISSUED SHARE CAPITAL AT THE DATE OF THIS AGREEMENT. PARTY D HEREBY ACKNOWLEDGES THAT, IN ACCORDANCE WITH CONDITION 4 OF THIS AGREEMENT, THE PROPORTION OF THE COMPANY WHICH IS REPRESENTED BY THE INITIALLY AGREED SHAREHOLDING MAY BE REDUCED IN THE FUTURE. SUCH SHARES SHALL NOT BE DEEMED TO HAVE BECOME VESTED SHARES UNTIL THE CONDITIONS OF AN ACQUISITION AGREEMENT HAVE BEEN FULFILLED IN THE PROCESS OF THE COMPANY BEING ACQUIRED BY A THIRD PARTY, SUBJECT ALSO TO THE FULFILMENT OF CONDITIONS 6, 7, 8 AND 9 LISTED BELOW. SHOULD PARTY D BREACH CONDITIONS 6, 7, 8 OR 9, THEN THE ORDINARY SHARES SHALL BE DEEMED TO HAVE BEEN CONVERTED TO DEFERRED SHARES AND SHALL BE AUTOMATICALLY RE-POSSESSED BY PARTIES A & B AT NO COST TO THESE PARTIES. IMMEDIATELY UPON VESTING OF THE SHARES, ALL RESTRICTIONS UPON SHARE DEALINGS OUTLINED BELOW SHALL CEASE TO APPLY AND THIS AGREEMENT IS THEN DEEMED TO HAVE BEEN TERMINATED.


1. Working Commitment: Party D will be expected to contribute full-time working involvement equal to that contributed by each of Parties A and B, until the acquisition of The Company. These working hours will be 0800 – 1900, Monday to Friday, with a 1 hour lunch-break, plus an additional 5 hours of work committed to the Company every week, to be performed at a time of each individual Party's choosing during that week. Changes to the working hours of Parties A, B or D must be by written agreement between by Parties A, B, C and D.

The additional 5 hours, together with the aforementioned expected working hours, until the acquisition of the company, shall be referred to in the remainder of this Agreement as the "Initially Agreed Involvement". The Initially Agreed Involvement amounts to 55 working hours per week, excluding lunch-breaks.

Party D shall contribute the Initially Agreed Involvement on the understanding that Party A and Party B shall also be committed to the Initially Agreed Involvement. A failure by any Party to contribute this number of hours in any week shall be discussed between Parties A, B and D in order that a mutually satisfactory solution can be reached. It is understood that this condition is put in place to define the working hours of the Initially Agreed Involvement with the aim of reducing potential working tensions between Parties A, B and D.


2. Termination:
"Devoted Time" is defined as the total number of hours committed by Party D to the Company from the date of this Agreement until the date of acquisition of the Company by a third party. This shall be calculated as the Initially Agreed Involvement multiplied by the number of weeks from the date of this Agreement until the working involvement of Party D is terminated or reduced, added to the total hours devoted by Party D to the Company at any subsequently reduced involvement level.

"Total Possible Time" is defined as the result of multiplying the Initially Agreed Involvement by the number of weeks from the date of this Agreement until the date of acquisition of the Company by a third party.

Party C and Party D reserve the right to independently terminate or reduce the working involvement of Party D in the Company. In such circumstances, Party D's resulting shareholding (“the Remaining Shareholding”) shall be recalculated at the time of the acquisition of the Company, by multiplying the Initially Agreed Shareholding by the Devoted Time, divided by the Total Possible Time. Any shares which exceed the number to which Party D is entitled under the Remaining Shareholding shall be deemed to have been converted to deferred shares and repossessed by Party A & Party B, at no cost to these parties.


3. Dividend Issues:
"Devoted Time Until Issue" is defined as the total number of hours committed by Party D to the Company from the date of this Agreement until the date of dividend issue. This shall be calculated as the Initially Agreed Involvement multiplied by the number of weeks from the date of this Agreement until the working involvement of Party D is terminated or reduced, added to the total hours devoted by Party D to the Company at any subsequently reduced involvement level.
"Total Possible Time Until Issue" is defined as the result of multiplying the Initially Agreed Involvement by the number of weeks from the date of this Agreement until the date of dividend issue.

Party D's dividend shall be calculated at the time of dividend issue by the Company, by multiplying the dividend to which would Party D would have been entitled, under the Initially Agreed Shareholding, by the Devoted Time Until Issue, divided by the Total Possible Time Until Issue.


4. Share Issue: If Party C deems that it is in the best interest of the Company to issue new shares to accommodate additional cofounders, advisors or new external investment after 01/04/2008 then Party D accepts that his shareholding (as an overall percentage of the Company) shall be reduced by the same proportion as the shareholdings of Party A & Party B.


5. Tie-in Conditions: If the terms of a partnership or acquisition agreement, entered into by Parties A, B, C and D with a third party, require the continued working involvement of Party D in the Company over a finite and specified period after the date of the partnership or acquisition agreement, then Party D is expected to comply with any such term as set out therein (provided such working involvement does not exceed the Initially Agreed Involvement without having obtained Party D’s consent to any such increase).


6. Tag-Along Rights: If Party A and Party B are selling a proportion of their shareholding in the Company as part of a partnership or acquisition process, Party D may insist that an equal proportion of his shareholding are to be sold to the acquiror at the same share purchase price in order for the partnership or acquisition to proceed.


7. Drag-Along Rights: If Party A and Party B are selling a proportion of their shareholding in the Company as part of a partnership or acquisition process, Party D is required to sell an equal proportion of his shareholding in the Company to the acquiror at the same share purchase price, should such sale by Party D become a part of the acquisition conditions.


8. Competition: Party D is not permitted to be involved in any companies deemed by Party A and Party B to be in competition with the Company for a period of 4 months from the date upon which written confirmation of Party D’s termination of involvement in the company is received by Party D.


Party D is also not permitted at any time nor for any purpose to make use of any intellectual property belonging to Party C extended to, but not limited to the artwork, source code or research material, without the prior written consent of Party A, Party B and Party C.


9. Share Sale: Party D is not permitted to sell or agree to sell any part of his unvested shareholding in the Company without the prior written consent of Party C.

Although I don't know anything regarding the legal amount of working hours.

 

[JohnnyW]

Basically I'm very happy with the changes that have been made to the contract, but it doesn't hurt to be aware of things. Thanks for the advice!

 

Clause 4 isn't so much of an issue, as it would mean that the two other co-founders would have their proportions reduced, too. Thankfully the contract has been re-worked to:

Soooo, lets assume you put a massive amount of work into this business, great - things are looking good, you can see your 4% is worth £££
Then parties A+B decide to take in co founders, lets say their spouses/partners and sell the shares lets say for arguments sakes 50% of what they hold, for whatever they feel, you in turn then lose half of your 4% meaning after all your effort you have got half of what you anticipated....

Still such a good deal? I would request that this clause is struck out, if they wish to sell shares then well and good, but don't have your shares tied in to what they do with theirs, this could be a very very foolish move.

As BR has rightly stated, you could have your shares diluted to almost nothing and there would be very little you could do about it, it could be a whole lot worse than the above scenario.

I would stop looking at the carrot being dangled for a moment and take a long hard look at the reality of the agreement.
Take care and good luck.

 

[JohnnyW]

I see. That makes perfect sense. The one plus side is that it would sour our working relationship for only 1 or 2%, so it's highly unlikely... that is, provided they care about relationship at the end. I have left myself stupidly vulnerable. Argh.

 

[i.m.]

Things have a habit of changing dramatically when money is at stake. When it is glint in the milkman's eye, to borrow a phrase, people are slighly more willing to compromise. That bargaining moment will soon pass.

BR

 

[mahutchinson]

From reading the contract it is unclear what the legal position regarding your shares is before acquisition of the company. "Vesting" is not a term which appears in company law - it relates generally to share options where the shares are held on trust before vesting in the owner. It seems to me that this is what is intended - that you have an option over the shares, in which case they should either be held by a trustee, or in fact need not even exist, until the acquisition is made. Regarding valuation, as previous posters say, I would also be very wary of the valuation of the business - what justifies it ? The idea of investing £20,000 and working for 18 months for no return is unattractive. The possibility of getting no return ever and relying entirely on your trust of the founders makes this a complete non-starter in my book.

 

[Cornish Steve]

Clause 1 is effectively illegal as it obliges you to work 55 hours per week and does not give you the opportunity to enforce your 48-hour working week entitlement. Something to bear in mind if this deal all goes belly-up.

Since when did anyone working for a startup ever work less than 60 hours a week? Sorry, but everyone I know who started work for this kind of company, especially when paid with shares instead of salary, works all hours to make it a success. The founders are hardly going to want to hire someone with an 'entitlement' outlook.