A few months ago, a CEO of a three-year-old startup (New york LLC) offered me an amazing opportunity to work for his firm as a co-founder (CTO) for an exchange of 35% equity in the company. The offer was contingent on successfully developing the technology needs. I have put a lot of effort in the last ten months to come up with a software and technology infrastructure that is necessary to drive the business. He is pleased with the product and we are ready to go live. Now he says instead of running the business with the current company (LLC), he wants to incorporate a new C-Corp in the Delaware state – as it actually helps us raise investment from VCs. He has devised the equity split as below for the new Inc. 10,000,000 total shares authorized 7,000,000 common 3,000,000 preferred 4,000,000 issued Value $0.00001 1,400,000 CTO (35%) 1,520,000 CEO (38%) 400,000 A Family member of CEO (10%) 280,000 A Family member of CEO (7%) 200,000 A Family member of CEO (5%) 100,000 A Family member of CEO (2.5%) 100,000 A Family member of CEO (2.5%) Only CEO and CTO are going to be the board members. My major concern here is how to protect my interest as a minority shareholder. Also why only 40% of shares are issued, remaining 60% are unissued. Why he wants to authorize so much preferential shares, 30% and another 30% common shares unissued. I have gone through a number of Internet articles that suggest startups typically authorize 10-15% preferential shares, but no attorney suggests 30%. Should I be concerned, as I have got only 35% shares, which is less than 38% that CEO has allocated to himself? What could be the worst situation I may encounter in the future? I read that Delaware state incorporation laws don’t protect minority shareholders. When I suggested him to reduce his stake by 3% by transferring it to one of his family members in order to make his stake equal to mine, he got so agitated and he declares he would NOT do that. He is not willing to change any of the above structure.
Hi, I'm not an attorney and you should probably seek advice from an attorney that specializes in this area of practice for specific advise.
In my 2014 book, Invest Local, I explain why it never makes sense to be a minority equity stakeholder in a small business.
Regardless of where the incorporation occurs or the documents you have in force, your future is tied to your relationship to this other shareholder. Any disagreements can have a devastating impact on your wealth, regardless of how 'right' you are. For example, do you have the financial resources to enforce your rights through the legal system?
The only question in my mind is can you trust this person and do you have a great working relationship? If you're uncertain in any way then you should probably have a 'plan b.'
Perhaps the securities you hold should have some kind of option that can convert them into debt under the right circumstances. This would put a minimum on the amount you are due if things fall apart.
Cheers and best of luck.
Arrange a call if you'd like to brainstorm together.
David
Answered 8 years ago
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