Last year saw a surge in the number of technology start-ups being formed in the UK according to a recent report of data provided by Companies House by the accountancy firm, RSM. Numbers show that a total of 10,016 new businesses operating within the tech sector were incorporated in 2017, a significant increase on the 6,300 formed in 2016.
Early stage investment into a new tech business to support its first steps is of course key to a businesses success. Whilst funding should undoubtedly be the initial focus of the stakeholders involved in any new venture, early consideration of how decisions shall be made at board level and how the relationship between shareholders will operate going forwards should also be a key focus.
Involving lawyers early on to advise on these areas will provide stability and certainty as the entrepreneurs involved manage their commercial tech offering from an initial concept through to an established and successful tech business.
Formalising the shareholder relationship
The founders of innovative start-ups attracting the attention of venture capitalists will certainly be required to formalise the terms of the equity investment through a Subscription and Shareholders’ Agreement. This document will typically cover key areas such as:
- Regulation of the day-to-day business operations of the company
- The issue and transfer of shares
- Compulsory share transfer events
- Rights of different share classes
- Reserved matters
- Drag and tag along rights
- Milestones for future tranches of investment
Ultimately, venture capitalists will expect to exert a great deal of control over a business in return for their investment and their overriding aim will be to secure a profitable exit within a desired timeframe (typically 3 – 7 years). As such, a Subscription and Shareholders’ Agreement will operate to ensure that these points are suitably covered.
Conversely, start-up founders progressing without VC investment will very likely have an existing personal relationship with each other and will understandably be more emotionally tied to the business. It’s unlikely that they will be plotting their ultimate exit strategy as early on as any external professional investor will be. So whilst there may be slightly different issues at play, there is still huge value to be had in founders moving away from continuing to use basic model articles adopted at incorporation and establishing a bespoke set of rules governing the constitution and shareholder arrangements behind their company.
By way of just one example, a common area of difficulty that may arise in the future for a successful start-up is how to deal with the situation of shareholders falling out with each other and how to secure a clean break for all sides in such an event. We are commonly instructed to advise in such situations and unfortunately, unless specific provisions have been introduced into a company’s Articles of Association or Shareholders’ Agreement, there will generally be no legal mechanism available whereby a shareholder can be required to sell their shares. This can lead to difficult negotiations and potentially, deadlock if no agreement can be reached.
Get it right first time
Properly drafted provisions covering this area can define when and how a shareholder will be required to relinquish their shareholding and will establish an agreed valuation procedure to cover various different leaving scenarios. Setting out this process at the outset is an invaluable way for shareholders to avoid the stress, time and professional costs that may otherwise be incurred if this difficult scenario arises in the future.
So whilst the fast-paced climate of new technology is being matched by fantastic growth in UK-based start-ups, founders are well advised to take a moment to consider longer-term goals and certainty as early as possible in order to steer a path through internal legal issues that could develop as their business takes off.
For more advice aimed at start-up tech businesses download our report - "Tech be nimble, tech be quick, tech don't forget the legal bit".
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.