For the fourth year running I've been giving legal advice to the winners of the Converge Challenge. The ingenuity and breadth of talent in Scotland never ceases to impress me and it's a privilege to be so closely involved with the winning companies as they make their way in business. The advice that I give is varied and ranges from IP to private equity and includes various commercial contracts, including share options. However, if I was forced to choose one piece of advice as being the most important, it would be that companies should hold on to their shares as if they were the Crown Jewels: STOP and take proper legal and accounting advice before allotting or transferring shares to the chap who designed the website; someone who promised to drag in scores of customers for the embryonic business; an old school friend who thought he should have some shares because he’d done a bit of work for the company, and so on.
Rather than being keen to hand out shares, owners of early stage companies should be doing everything in their power to keep them: they can be very hard to get back. I’m not saying that you should never pay suppliers with shares, but I am concerned that shares are sometimes allocated to people who have, in many cases, supplied a one-off service to the company and are given an ongoing stake in its value, even if they may have no further involvement in growing that value.
Some of the problems that can be caused if a company has minority shareholders are:
- it can be off-putting to serious angel and VC investors;
- if not documented properly it can lead to probems with control of the company and also jeopardise a trade sale if the minority shareholders can’t be ‘dragged’ (obliged to sell when the majority shareholder wants to sell);
- it can result in a whole host of people expecting (possibly wrongly) to have a say in the running of the company, which can be an unwelcome distraction; and
- it may cause unintended and expensive tax consequences.
If you insist on paying people with shares, please bear in mind that you should:
- file the correct paperwork with Companies House and write up the company’s statutory books (unfortunately this is a boring task);
- strongly consider amending the company’s articles so that you don’t jeopardise control or end up having a trade sale blocked by the minority; and
- consider granting share options instead. These can be subject to performance targets so that if the option-holder doesn’t do what was expected, the options lapse and the company keeps its shares. It may also be possible to grant tax-efficient EMI Options in many circumstances.
If you’d like to discuss how we can help to keep your company structure clean and workable please get in touch with me at austin.flynn@morton-fraser.com or on 0131 247 1260.
