A Great Balancing Act: Investor and Founder Interests

LegalVision’s clients face unique challenges in their startups and businesses. Below, we look at an all too familiar question asked by founders needing to take personal leave. Can they retain their shareholding in the company?

Meet IT Developer, John

John is an IT developer who, along with two friends, founded NewCo Pty Ltd, an IT company that provides software as a service (SaaS) to a growing customer base. When the company accepted money from an interested investor and signed the Shareholders’ Agreement eight months ago, he and his co­founders were busy building their company, and at the same time overwhelmed by legal documentation.

Two weeks ago John became very seriously ill. John had to leave his employment role last week with NewCo Pty Ltd, without any clear return date. So, he asks can he retain his shareholding in the company?

Good Leavers and Bad Leavers

Good and bad leaver provisions in a Shareholders’ Agreement govern the consequences if a founder leaves their employment with the company, such as retention of shareholdings.

Generally, a good leaver will retain his or her shareholding, whereas a bad leaver will not. Whether a person who leaves a company is a good or bad leaver depends on the circumstances that give rise to their leaving the company, and how the Shareholders’ Agreement frames the governing clauses.

Balancing the Interests of Founders and Investors

A Shareholders’ Agreement that balances the interests of founders and investors will set out a list of circumstances giving rise to a leaving person classed as a bad leaver. These may include:

• Failure to render services;
• Breach of statutory duties as a director;
• Breach of the agreement;
• Repeat of a breach despite receiving an earlier notice not to;
• Not acting in interests of the company; or
• attempting to dispose of shares other than as agreed.

A Shareholders’ Agreement will generally define good leavers as a person who isn’t a bad leaver.

Promoting the Interests of Founders

Naturally, the narrower the construction of a bad leaver event in the Shareholders’ Agreement, the more likely it will be for founders who leave the company to retain their shareholdings. Returning to John, it is then likely he will keep his shareholding.

Promoting the Interests of Investors

Alternatively, a Shareholders’ Agreement that prioritises the investors’ interests over the founders will generally expand the definition of bad leaver with broad wording and extra bullet points.

Under this construction, a good leaver is defined very narrowly by reference to one or two points, such as mental incapacity or death. Then, even if John is ill for many years, it is unlikely he would retain his shares.

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Founders will benefit from a Shareholders’ Agreement that constructs bad leaver provisions and good leaver provisions in a way that at least balances their interests with those of investors.

Questions? Get in touch with LegalVision’s startup lawyers on 1300 544 755.