FOUNDER EQUITY

&

STARTUP

FINANCING

uwakili.com

•US and Hong Kong Licensed Attorney

•Founder/Co-Founder for multiple startups

•Former General Counsel for a technology and new

media VC Fund/Incubator in Asia

•Angel Network Mentor/Investor

JOHN REYES FREEMAN

FOUNDER EQUITY

Found

er

Equity •Founder Equity: Not a legal term but used in common parlance to

refer to the shareholding (ownership) given to someone who

participates in the initial creation and early stages of a startup. Also

referred to as Founder Stock

•Biggest question often faced by startups is allocating the equity

among the Founders

•Most startups equally divide Founder equity—Easiest way but not

best way to do

•In situations where a company’s equity is held equally among the

Founders and they no longer agree on direction, the lack of a tie-

breaking vote is often fatal to the company’s ability to make

decisions and move forward

•Founders need to be aware of dilution of equity over time

Founders’ Pie Calculator

The Founders’ Pie Calculator by Frank Demmler

VESTING

❖ Vesting is the process by which a co-founder or an employee accrues equity interest

in a startup

❖ Shares/Options granted do not automatically become the property of

employee/Founder, but are given over a period of time

THEREFORE

❖ Vesting is the method of tying equity ownership to time served with the company.

❖ Such Equity interest is no longer subject to forfeiture (or repurchase by the company

if the equity interest is restricted stock) upon the departure of such co-founder or

employee.

Common Vesting Terms:

❖ For employees is when 25% of equity vests after 1 year of

service (often referred to as a “one-year cliff”), and the

remainder vests monthly in equal installments over the next

three years.

❖ Founders will often have different vesting schedules to reflect

their early commitment to the company and higher level of

involvement.

• Vesting is to retain key staff (including Founders)

• Usually it is a 4 Year vesting period

• Outlined in a Vesting Schedule in Employment or other

agreements

• Vesting can be tied to milestones instead of time

CLIFF PERIOD:

• Cliff is a trial period where no shares are granted according to the Vesting

Schedule. Shares are vested at the end of the cliff period

• Normally this is 1 Year

• 4 Years with a One Year Cliff is the typical vesting schedule for startup founders’

stock.

• Under a 4 years with a one year cliff schedule, founders vest shares over a four

year period. Because of the one year cliff, the founders will not vest any shares

until the first anniversary of the founders stock issuance. Upon the one-year

anniversary, the founders will each vest 25% of their total shares. Vesting will

usually occur monthly after the cliff.

Vesting

4 Year Vesting1 Year Cliff

KENYAN LAW PERSPECTIVE

VESTING AND CLIFF

PERIOD

VESTING

❖ Not envisioned by New

Companies Act 2015

❖ But as can be dictated by private

contract.

❖ Therefore include Vesting

provisions in

Shareholders/Employee

Agreements

❖ Also can be included in Articles of

Association.

❖ Notify the Registrar of Companies

periodically upon vesting via

filling: Interim Annual Return,

Return of Allotment, and Board

Resolution (See @ uwakili.com)

CLIFF PERIOD

❖ Not envisioned by New Companies

Act 2015

❖ Dictated by private contract.

❖ Included in Shareholder or

Employment Contract.

❖ Also can be included in Articles of

Association.

SHARE TRANSFER

Right of First Refusal

❖Entitles the holder of the right to be the first to “refuse” a deal that the person subject to the right receives for the purchase of stock.

❖From a founder perspective, this is the right of the company to buy the founder’s shares if the founder tries to sell them to a third party.

Applies in the same manner from an Investor’s perspective.

See: Uwakili-Deal Dictionary.

❖Typical clause investors want to see, often in Shareholder Agreement

❖Designed to control who can hold shares of the company

THEREFORE

• BEFORE a shareholder can sell shares to a third party, the Shareholder must offer to sale on the same terms as discussed with third party via a Transfer

Notice to the:

1. Company, if company doesn’t want to purchase

2. The other shareholders/investors, if they don’t want to purchase then to

A. If more then one other shareholder, then they can purchase pro rata their holdings (i.e. if hold 10% of shares, they can buy up to 10% of the offered shares).

B. Should a shareholder(s) not want to purchase, then the ones who do can “oversubscribe” to buy more then their holdings percentage.

3. The third party buyer

• Usually covers all “transfers” of shares. • Transfers include offers to sell, assignments, pledges (for example, to

secure a debt), transfer to family or trusts, involuntary transfers such as those that happen upon death or divorce, mortgages, grants of

options, and encumbrances, of the shares themselves or any interest in the shares

• Often smaller companies want to clearly state what transfers are subject to ROFR, i.e. offers to sell

• Also state a time limit for each step so it doesn’t drag on for months while a party decides if they want to purchase or not. I tend to say

10,15, or 30 days

Co Sale Provision (aka Drag Along, Tag Along)

• A tag-along right is commonly used to protect minority shareholders'

rights. Majority shareholder sells shares the minority shareholder is

entitled to tag along with the majority shareholder, and sell their

shares. This is optional, minority shareholder doesn’t have to sale

• A drag-along right, however, protects the majority shareholders' rights.

According to the Shareholder Agreement of the parties, if

shareholders representing certain majority percentage of the shares

(usually I say 70-75%, but can be 51%) decide to sell their interest, the

minority shareholders are obliged to “drag along” and sell their interest

under the same conditions

Kenyan Law

Model Articles of Association

TRANSFER OF SHARES

Article 25 to Article 32

Article 25: Execution of instrument of transfer of shares

Parties to instrument of transfer are known as Transferor and

Transferee.

Instruments include, Agreement to Transfer shares and ….

Completion of Transfer is marked by having the Transferee’s name

entered into the Register of Members.

Article 26:Who may transfer shares

● Transfer of shares must be in writing.

● Form of writing can be as the directors may approve, or as per

regulations provided by the Registrar of companies.

Article 27: Decline of transfer of shares

Directors have veto power on Transfer of shares.

Article 28: Recognition and nonrecognition of instrument

of transfer of shares

Instrument of transfer may fail if:

---} A certificate of shares is not given.

---}Fee for certificate is not awarded

---}Transferee is a infant, partnership or person of

unsound mind.

Article 29: Duration of notice of refusal of transfer

● Notice of refusal to transfer shares by the directors should be

sent two months of company notification of the transfer

Article 30:Suspension of registrations of transfer

● The suspension should not be more than thirty (30) days in any

year.

PRE-EMPTION RIGHTS

ARTICLE 33

Sub Article 1: Pre-emption rights in relation to transfer of

shares

● Pre-emption rights have to be exhausted before any Transfer of

share is done.

Sub Article 2: Requirements of company members who

wish to transfer their shares

These are:-

● Members should give notice in writing to the Company.

● The price is agreed upon by the Vendor and Directors or the

auditor may give the fair price.

● Company may state that unless all shares are sold by the

Company, none should be sold.

Sub Article 3: Certification of the price of shares and the

requirements of the vendor in relation to the shares

● The auditor is asked to certify the fair price.

● Company should provide the vendor with the certificate.

● The vendor may cancel the Company’s authority to sell the

shares within 21 days after receiving the certificate of price.

Sub Article 4: Invitation of members to apply for the transfer shares

● The Company sends a notice to members informing them of the share

price and number of shares and to apply for the shares within 21 days.

Sub Article 5: Conditions governing allocation of transfer shares

● The directors allocate the applied shares to members.

● Applicants are not allowed to take more than the maximum number of

shares specified.

● Company gives notice of allocations to the vendor or company member.

● The time and place the shares shall be sold should be stated in the notice.

Sub Article 6: The position of the vendor and purchaser of the

transfer shares

● The vendor should transfer the shares to the purchaser at a specified time

and place.

● The purchaser is then registered as the holder of the shares.

Sub Article 7: The right of the Vendor with regard to transfer shares

● The vendor may be free to transfer shares not allocated by the Directors to

any person.

TRANSMISSION OF SHARES

Article 35 to Article 38

Article 35: Company recognition of persons who will have title to an interest in

the shares of a dead member of the Company

These are personal representatives of the deceased and survivors if the deceased was a

joint holder.

Article 36: Conditions for registration of the holder or transferee of shares

which are:-

● Member to produce evidence of entitlement to the shares.

● Member to elect himself or another representative to be the holder of the shares or as

transferee.

● Directors may decline or suspend registration.

Article 37: Requirements to be met by persons registering

● Send a written notice to the Company stating the person elected as the holder of

shares. This may be the member or another person of their choice.

● Testify to the election by executing a transfer of shares to the person chosen.

Article 38: The rights conferred on persons registering

● Persons to be entitled to the same dividends and advantages as other shareholders.

● Directors may withhold payment of all dividends, bonuses or money as they deem fit.

EXCLUDED TRANSFERS

Article 34

It provides instances where pre emption rights will not

apply. These are:-

● Where the transfer is approved in writing by all the

members

● Any transfer by a corporate member to an associated

company

● Any transfer by a corporate member to a company

formed to acquire the whole or a substantial assets

or part of the undertaking.

Departure

• Repurchase of Unvested Shares

• Usually initial grant/purchase agreements will have a clause to repurchase unvested shares at cost Founder paid.(i.e. 100 unvested shares @$1, then Founder is paid $100)

• Vested shares Founder keeps or has the right to sell (subject to the First Right of Refusal clause)

• This is documented and signed by both parties. Simple note saying unvested shares repurchased for $XXX, payment was given in full, and founder forfeits the rights to such is ok

Departure

• Termination Certificate/Notice

• Make sure to get departing Founder to sign a notice of termination. This usually is referenced when the Founders all sign their IP assignment agreements at the formation/start

• Acts as part of governance and also as clearance to any work product IP generated by Founder

Departure

• Directorship/Board

• If Founder is a Board member or a Company director, have departing Founder sign a simple resignation from such position

• File the removal with relevant government entities

• In the event this leaves open a Board seat, have the Board change the quorum requirements (if applicable)

Kenyan Law Perspective

Transfer & Forfeiture of shares

TRANSFER

Resignation letter

Transfer of Shares Agreement

Transfer Deed

Affidavit

FORFEITURE

Resignation letter

Interim Annual Return

Ordinary Resolution

Cessation of office

Need Transfer or Forfeiture of

shares documentation?

STARTUP FINANCING

TYPES OF INVESTMENT

• Convertible Debt• Basically a loan to the company that may be exchange for equity

• Often done by providing the investor with a Convertible Note

• Equity Investment• Typical investment where shares/stock of company is sold exchange

for money or valuable consideration (IP, work/idea, etc.)

• Often done by providing the investor a Term Sheet and a Share Purchase Agreement

Convertible Note

• Investor loans money to company for a fixed period (normally 1 – 2 years) at a standard interest rate

• At the end of the loan term, investor can choose to either:• Receive the money back plus interest; or

• Convert the amount of the loan into equity (shares)

• Conversion occurs with a discount and/or a fixed valuation• i.e. 20% discount, so investor pays 80% of the value of the share ($100 share

value, they pay instead $80 per share)

• With fixed valuation, it should be lower then current valuation, so investor receives more shares for same amount

NEED A TERM SHEET?

Term Sheet / Share Purchase Agreement

• Term Sheet outlines particulars of the investment, the company, how much is being invested, how many shares the investor receives, and the class of the shares (common, preferred, voting/non voting, etc)

• Preferred shares are normally given to investors. This means should the company be wound up, they get first rights to receive any money

• Share Purchase Agreement outlines the particulars of the purchase and the amount paid along with the actions both sides must take to complete the transaction (i.e. issue the share certificates, sign Shareholders Agreement, etc)

Need a Share Purchase Agreement?

DOCUMENTATIONuwakili.com

• Founder Equity Calculator

• Convertible Note

• Term Sheet

• Shareholder Agreement

• Share Purchase Agreement

• Transfer of shares by a company director

• Forfeiture of shares by director on cessation of office