How Can Founders Retain Some Control of Their Startup?

This article continues our analysis of the “Open Source Seed Financing Documents” released by the Australian Private Equity and Venture Capital Association Limited (AVCAL). Below, we turn our attention to the AVCAL Shareholders Agreement and how founders can negotiate to retain some control of their startup.

Investor Control Under the AVCAL Shareholders Agreement

Under the AVCAL Shareholders Agreement, a director appointed by the investors effectively has the power to veto particular business decisions whether or not the directors, including the founders, support the change.

These critical business matters are set out in Schedule 2 of the Shareholders Agreement. They include:

1. Business Plan

On a board with five people, being four founders and a single director representing investor interests, the director representing the investor can, if he or she so wishes, veto a business plan which the other founders agree to and collectively perceive as the needed direction for the company.

2. Employee Appointment or Removal 

Suppose startup founders have a mutual friend who they perceive as an ideal fit for the business. Ultimately, investors decide whether or not to hire him or her through their appointed director’s right to veto critical business decisions.

3. Entering into a Partnership, Joint-Venture, Profit-Sharing Agreement, Technology Licence or Collaboration 

The effect of this clause, read in full, is to enable the investor’s appointed director to prevent the founders of a company from entering into, amongst other things, a material technology licence if that director opposed the arrangement.

Consequences of Investor Control

The power of the investor’s appointed director to reject a decision that is unanimous among the founders’ appointed directors across such a broad list of categories gives the investor(s) significant control. Importantly, however, directors have a fiduciary duty to act in the best interests of the company. Also, they will want to do what is best for the company so that their investment grows.

Recommendation

If a startup uses the AVCAL suite of documents, founders should review the critical business matters set out in Schedule 2 of the AVCAL Shareholders Agreement in detail and ask themselves:

1. Are these critical business matters decisions which we want the investor director to be able to control?
2. Should we delete any of the matters listed in Schedule 2 and deny the investor director the veto power, or amend the list so as to limit the investor director’s powers?
3. Are the monetary thresholds appropriate, particularly as the company grows?

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Our startup lawyers are experienced in using and negotiating the AVCAL suite of documents. If you have any questions, get in touch with us on 1300 544 755.