What kinds of provisions might be risky when setting up shareholder agreements? You don’t want to put something into place that is ultimately going to be toxic to future investors. An example of that would be something that I’m asked […]
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Shareholder Agreements and Ownership Dilution

October 19, 2015

What kinds of provisions might be risky when setting up shareholder agreements?

You don’t want to put something into place that is ultimately going to be toxic to future investors.

An example of that would be something that I’m asked about frequently by entrepreneurs as they say, “Well, my investor expects to always have a specific percentage in the company in the future, so hypothetically let’s say, the investor expects 15% of the company, but the investor expects that not only today but for all time: That is a toxic provision.

In fact, there’s not even a good way to draft such a provision, but if such a provision is included in the documentation, it’s going to become a huge problem for future investors because future investors are going to assume that everyone is essentially in the same boat, and therefore, everyone is subject to dilution in the same fashion.

If you try to protect one particular participant from dilution of their percentage it’s going to be an impediment to future fundraising. That’s just one example of a provision I run into frequently or request that I receive frequently, and I often see casually written into a self-drafted document, which can create big problems in the future.

 

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