0

I'm about to sell shares to an angel who is going to become the majority shareholder of my company. The money will go into the company as new shares. I can only pocket it through salary agreements.

One of my concern is the new angel can decide to cut me off. They can do so by breaching fiduciary duties such as diluting my shares.

As a small timer, I won't have any money to bring them to courts if this happens.

How would I go about (in these negotiating times) to avoid such a scenario?

EDIT

I'm selling shares to raise capital for my company to grow, hence why the angel is needed. He wants control of the company, thats fine with me. However, I've heard many stories of founders been cut off (through clever schemes) and eventually end up with nothing, as in ZERO $$. I'm in Australia, so I do trust the judiciary system to protect me in any breach. Though my concern is the legal fees associated when such an event happens.

  • If you can't afford to have a lawyer, you can't afford not to have one. Find a way to get a lawyer. – Nij Feb 10 at 0:53
  • 1
    You can't protect yourself. Either get a lawyer or don't do the deal. – Jack Fleeting Feb 10 at 1:47
1

It is important to only enter into this partnership with someone you trust but you and the investor will have different incentive structures and may very well have different views of the company as time goes on. The investor does not need to be a dishonest person to decide that you might need to be demoted from CEO at some point, for example. You may differ on the need for future investments or the need to both accept dilution to bring in the investment. If you are the CEO they could legitimately worry that you will spend their money in an wasteful manner.

Usually an angel is a minority shareholder and they need to protect themselves from you diluting or otherwise screwing them. They would insist on a shareholder agreement that protected them, usually worked out with the help of their attorney and yours. If the angel has a good reputation in the local start-up community you may be able to find an attorney to work for the company who will get paid by the company after the investment comes in.

A note - an investor has a duty to themselves to protect their money. If they become a board member they also have a fiduciary duty to the company but not to you personally. In their fiduciary duty to the company they could honestly think the best course of action is to bring in an investor or a new CEO in a way that is detrimental to you. A good agreement might protect you but it is their money and they need flexibility to deal with unforeseen circumstances. It will no longer be your company after the investment.

|improve this answer|||||
  • Thanks. This is what I'm scared off, if they breach they're fiduciary duties, I won't have $50K in my bank account to pay legal fees to sue them – user1034912 Feb 10 at 4:48
  • 1
    What duty do you think they have? The point of my answer is there are things they can do without breaching any duty I can think of. Can you spend the invested money on a lawyer to help get a good agreement of some sort up front ? – George White Feb 10 at 5:29
  • I am calling up a lawyer. But they seems to be pretty standard in their agreements, which more or less states If anything goes wrong, you can sue... Yeah, but with what money? – user1034912 Feb 10 at 5:32
  • 1
    REALLY? Oh George that's a great idea... So, I suggest a clause if there are any fiduciary duty breach lawsuits on the company or directors shall be borne by the company itself? Sound rather awkward. Is this standard? – user1034912 Feb 10 at 6:11
  • 1
    @user1034912 "I suggest a clause if there are any fiduciary duty breach lawsuits on the company or directors shall be borne by the company itself?" There is no fiduciary duty, (see last paragraph here), since the buyer of your shares would be the "angel", not the company. Thus, the company is unlikely to agree to cover legal fees or angel's liabilities. Even if it were standard practice, it will be superseded by whatever is provided in your contracts. – Iñaki Viggers Feb 10 at 12:29
1

How would I go about (in these negotiating times) to avoid such a scenario?

You can't, although a well-thought contract reduces the chances of loss. Even if you hire an expensive attorney and sue the buyer or company, you still are at risk of losing everything because there are many incompetent lawyers and many corrupt judges. The judge presiding your case might be literally a felon whose manifesto in court is to favor "anybody who's powerful".

Although you refer to negotiations times, it is important to keep in mind that negotiations are just a process in preparation for something enforceable and consequently much more important: the contract. In the event of discrepancy, a contract will almost always prevail over any representations made during negotiations.

That being said, the first thing for you to determine is what exactly you would prefer to accomplish (i.e., to sell your shares or to keep them) and why. This is not clear from your post and comments in other answers.

For instance, your mention that

I can only pocket it through salary agreements

suggests that, instead of receiving a lump sum, you would be paid in installments under color of an employment relation.

But then you mention some concern about dilution of your shares, albeit without elaborating what relation you think it bears with a breach of fiduciary duty or with the event of selling all your shares at once. What does dilution have to do with the salary agreements you mention?

You don't specify whether you currently perform any functions at the company, but your mention of salary agreements prompts the question: Is an employment relation necessary for the sale? more specifically, is it necessary to intertwine a shares transaction with an employment relation?

Your status as employee & former shareholder could give the counterparty an opportunity to disrupt your entitlement by tortiously alleging that you have a conflict of interest.

Will your employment be at-will? how will your "salary" agreement differentiate between compensation insofar as an employee versus the proceeds from the transfer of shares?

Is it better for you to (1) sell all your shares at once and be paid in installments, or (2) sell them in batches at different times so you retain the ability to decline further transfers/agreements if the whole matter is not working for you?

These are only few of several issues you need to decide before you get to the point of reflecting your conditions in a legal document (i.e., contract) for the sell-off of shares.

It also appears that you are confusing the meaning or applicability of fiduciary duty in your case. The duty arises in contexts where a party expectedly places special reliance on representations made by his agent (such as an adviser, an attorney, etc.) or person of superior position. Contract law certainly is premised on a covenant of good faith and fair dealing, but fiduciary duty seems inapplicable in your matter because it is about an arm's length transaction: a context in which two shareholders (namely, an "angel" prone to getting ticked off and you) have opposite interests.

|improve this answer|||||
  • Thanks Inaki for the well written answer. I'm selling shares to raise capital for the company to grow, hence why the angel came in. He wants control of the company. But I've just heard many stories of founders been cut off (through clever schemes) and eventually end up with nothing, as in ZERO. I'm in Australia, so I do trust the judiciary system to protect me in any breach. Though my concern is the legal fees associated when such event happens. – user1034912 Feb 11 at 1:13
  • @user1034912 "He wants control of the company". It seems that with this "angel" you would be changing one problem for another and later regret it. Try finding other ways of funding your company that won't put you in peril. This "angel" very likely sensed your financial constraints already (such as your de facto inability to take him to court if he acts wrongfully), whence a scenario where he takes advantage thereof is just a matter of time. – Iñaki Viggers Feb 11 at 16:19
0

1. Don't do deals with people you think might be criminals

If you are contemplating entering a business arrangement with a person who you think might break the law in order to screw you over - find another partner.

2. If you must deal with criminals, be prepared to lose everything and walk away

If this guy is really the least bad option; make sure the deal is so good now that you don't care if he steals from you later.

|improve this answer|||||
  • Thanks Dale, but we can never know. Sometimes we can accidentally tick him off by disagreeing with him and he takes it personally. – user1034912 Feb 10 at 4:42
0

It is important to only enter into this partnership with someone you trust but you and the investor will have different incentive structures and may very well have different views of the company as time goes on. The investor does not need to be a dishonest person to decide that you might need to be demoted from CEO at some point, for example. You may differ on the need for future investments or the need to both accept dilution to bring in the investment. If you are the CEO they could legitimately worry that you will spend their money in an wasteful manner.

Usually an angel is a minority shareholder and they need to protect themselves from you diluting or otherwise screwing them. They would insist on a shareholder agreement that protected them, usually worked out with the help of their attorney and yours. If the angel has a good reputation in the local start-up community you may be able to find an attorney to work for the company who will get paid by the company after the investment comes in.

|improve this answer|||||

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.