Open Source Startup: Shareholders Agreement & Memorandum of Incorporation Templates

Welcome to Chapter 6 of Open Source Startup: Shareholders Agreement & Memorandum of Incorporation Templates. For a table of contents, head over to the Introduction here

This is Chapter 6 for a reason. These documents should be one of the first things you get straightened out in your startup - but often aren't. Sometimes, you need to get a feel for the environment first. Sometimes, you just procrastinate.

Be warned and be warned well: you make contracts in case of divorce, not in case of happy marriage. You need contracts when people fight, not when people get along. The longer you leave these documents, the harder they get.

And they get hard. They get complicated. But this is just a nut you're going to have to crack.

Let's start with a few definitions and some scare tactics...

What is a Shareholders Agreement? It's used to govern the relationship between the various parties in their capacity as shareholders (and often in their positions as directors) of your company. Any aspect not covered by your Memorandum of Incorporation needs to be covered by your Shareholders Agreement.

What is a Memorandum of Incorporation (MOI)? This sets out the rules, duties and responsibilities of shareholders, directors and others in relation to your company.  The Companies Act imposes certain requirements on the content of a MOI - a few default company rules / alterable provisions, which companies may accept or alter as they wish as long as it's in line with the Companies Act (that last bit is important).

Did you know that an MOI is public? You can hop along to CIPC and have a look at any company's MOI. On the other hand... a shareholders agreement is private - it contains the rules you don't want in the public domain and the express written agreement between the current and future owners of your business.

What can go wrong? Shall I list the ways?
  • Shareholders tend to think that because they know each other and have a good idea, they'll be successful together. Not always.
  • Shareholders think that when they start out there's no major value in the business – so they'll get to the shareholder’s agreement once value is created. 
    • Problem 1. That often comes with a tax burden as shares in a company with value are seen as an asset and immediately taxable. 
    • Problem 2. Negotiation gets trickier the deeper you get into the business. It can get ugly. Trust me. 
  • If a shareholder dies, their shares could form part of an estate and a family member could become your new business partner. How much do you love Aunty Pat?
  • If a valuation has not been determined in your shareholders agreement, it's often impossible to get two parties to agree to a value at a later date. Cue legal battles.
OK, let's hop straight into the templates - and a few things you need to think about...

To think through:

Shareholder Agreements vary a lot. Precious little snowflakes they are. Just make sure you understand them - and make sure you feel they're fair. In my experience, the shorter the better, just cover your bases. 

Forced Sale clauses. You'll see these pop up quite often, usually in investor-backed startups. In their simplest form, they exist to protect 51% of the shareholders from being blocked during an exit or major funding event by a minority shareholder. Sucks for the minority - but often necessary to get an investor on in the first place. They can also be used to get rid of troublesome shareholders (but, yeah, cue legal battles).

Your MOI is YOUR rule book. You've got a fair bit of latitude to tweak the rules of how you operate, when you meet, how many directors you have and what their mandate/liability is. The trick is not to contradict the Companies Act. And so going with something basic and simple like this template is usually the best way to start. 

Agreements need to be entrepreneur-friendly. If something feels wrong, question it. I've seen 75-page monster agreements that were designed to only protect the investor. Remember, an investor is an enabler. If the founder gets locked out, so does his/her incentive to grow the business. Agreements betweeen shareholders, founders, investors and staff need to be fair and friendly. 

Watch for the point of dilution when you lose control. Many a whiskey was required during the effects of a founder dilution. There's usually 2 points to watch out for. Ordinary Resolutions (read your MOI) which require 51% of votes/shares to pass. Special Resolutions which require 75% of votes/shares to pass. Keep an eye on your percentages. It's like parliament for business - coalitions can occur in the unlikeliest of places...

Say it with me: "a clean company is a good company". One day, you might want to be acquired. Do not underestimate how much easier it'll be if you've got your compliance ducks in a row. 

Enjoy going down the rabbit hole!

Disclaimer: The information in these posts work for us. I cannot guarantee that it'll work for you. Consult the right professional to make sure.

Extra Disclaimer for this post: This is probably enough to get you started, enough to offer a little protection if you can't afford a lawyer. But consult a lawyer as soon as you can. They're the experts. And hire a company that offers outsourced secretarial services. It may feel like an unnecessary expense in the beginning, but trust me, it'll cost a lot more to fix down the road. 


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