Many successful small businesses and nearly all successful big businesses have investors and a board of directors. It’s common for an entrepreneur to decide early on that he or she needs access to the capital (and sometimes knowledge and connections) that an investor can provide. Dealing with an investor and board of directors can be a delicate matter. It’s important that you choose investors whose interests and goals are aligned with your company.

The relationship that is negotiated between the founders of a company and the investors is set out in the company’s shareholders agreement.  Unlike the standard Replaceable Rules or Constitution, the shareholder’s agreement is written specifically for your company, to reflect how your company will be run.

This article sets out issues to consider before bringing on board an investor and setting up a board of directors. Discuss and resolve these issues early; once you sign the shareholders agreement it can be difficult to unwind your decision.

1.       Board of Directors – Overseeing Management for Investors

Although the shareholders of a company ultimately control the business, it is the board of directors that oversee management and management decisions. An investor buying a sizeable stake in the company will generally want to appoint a director to oversee his or her investment. The membership of the board of directors needs to reflect the shareholding in the company. For example, if you want a 5 person board, then each investor may be able to appoint 1 director for each 20% of shares they own.

It’s important to consider how directors will be appointed and removed from the board. An investor won’t want the founder to be able to remove his or her director at will.  This undermines the investor’s influence, information and the investment. On the other hand, the founder will not want to have to deal with a recalcitrant director if at all possible. The rights of the board of directors and the  shareholder need to be balanced.  For example, you may agree that (i) the appointing shareholder has the right to remove and replace a director at any time and (ii) an 75% or unanimous vote of the board of directors can remove a director, but only the appointing shareholder can appoint the new director.

2.       Directors v Shareholders – Voting Power and Control

The shareholders agreement (and constitution) sets out what the board of directors or the shareholders can vote on. You can agree which decisions must be made by shareholders, including which require a majority (50% or more) or supermajority (75% or more).  For example 75% of shareholders must agree before selling the company, selling major assets or taking on significant loans.  Decisions not listed are generally made by the board of directors (50% or more), or you can agree a list of decisions that require a super majority of directors (75% or more).

It’s important for a founder to understand the division of power between shareholder and the board of directors, to decide what decision making powers each will have and how you will break deadlocks.

3.       Management v Directors – Managing your Company in Conjunction with a Board of Directors

Some start-ups and small business rarely hold formal board meetings.  The founders of the company may make all the decisions regarding the company’s direction as they go.

Once you bring on board an investor, they’re likely to want formal board meetings. You need to work out what decisions will be the prerogative of management, and which need to be decided by the board of directors. You don’t want to have to double check every day decisions of management, with the board. The balance of power between the board of directors and management can be detailed in in the shareholders agreement.

4.       Exits

Discuss each party’s expectations surrounding exits, and agree on exit strategies, before signing up a new investor. Are your investors investing for long term? Are you looking for a quick exit or wanting to build your company over a period of time?

Include clauses relating to tag along rights, drag along rights, and rights of first refusal in the shareholders’ agreement, in order to ensure that parties are treated fairly in the event of a partial or complete exit.

Conclusion

Many businesses require investment in order to grow. Bringing on board new shareholders is exciting, but make sure you discuss the above mentioned issues in detail before agreeing to an investment; you need to be aligned with your investors as they are key to the success of your business. To find a lawyer, contact LegalVision on 1300 544 755.

Ursula Hogben

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