Imagine for a moment that you started a business and have been running this business on your own for a while , and then suddenly, you realise that you needed to scale and expand the business, so you bring in three of your friends and you all agree to do a fresh limited liability company registration for the purpose of the expansion.
Imagine that you retained 40% of the business and gave your friends 20% each, thereby taking up the entire 100% shares of the business.
Now imagine that barely 3 months into the business, you and your partners are already having issues and one of them actually leaves the business.
The second friend also leaves two months after the first one left thereby leaving only 2 of you to run the business.
Let us assume that Tope Johnson is the owner of the business. Uzo and Garuba had left.
The remaining partner being just Tope, and Bright.
The implication of this is that 40% of the company is being controlled by the two ex-co founders (Uzo and Garuba) who still have right to those shares.
Nothing destroys a start up with Co-Founders or Partners faster than when a Co founder leaves the business.
Trust me, it is demotivating and in most cases, the companies never almost survive.
From the Scenario created above, I can tell you three fundamental mistakes that Mr Tope made in his business.
1. Not having a Co-founders Agreement before registering a company.
One of the mistakes small business owners make When they begin to fantasize with the idea of scaling or expanding their business especially when there are potential investors and partners is to quickly go and do a Ltd liability Company registration.
They have read and heard how I mention several times that an LLC (Limited Liability Company) is better than a business name, so boom! they hurriedly register a company with the investors and issue shares blindly and without justification too.
Registering an LLC where you have Co founders, directors and shareholders is on the presumption (though rebuttable) that you understand the legal implication of what you are getting into.
So what I always strongly advise my clients is that they have an operating document such as a Co-founders or Shareholders Agreement to be signed by all of them prior to registering the company.
This Agreement which will contain several other very important terms will ensure that all the Co-founders or shareholders are on the same page thereby reducing the possibility of disputes and having a partner walk away after the company has been registered as even those will be covered by the Contract (Dispute resolution and Exit Clauses)
The second mistake made by Mr. Tope and this is perhaps the most important is this:
2. Failing to include a share vesting schedule and a one year Cliff in the “supposed Agreement”
A vesting schedule is a clause in a shareholders Agreement that ensures that a person doesn’t get the entire amount of shares issued to him right away.
The shares are vested for a period of 4 years ideally with a one year cliff, so that the equity or shares are actually earned at a certain percentage per year.
What that means is that if a co founder leaves in less than a year of starting the business he gets nothing of the shares issued to him.
This is called the Cliff period.
if he leaves within a year after the cliff period he gets 1/4 of the total amount of his shares and so on and so forth until the shares are fully vested.
The essence of share vesting is to ensure that all the Co-founders are actually committed to the business and to ensure that they remain in the business for the long run.
Now back to the Scenario; if Tope had included a share vesting clause in his Agreement with his co-founders, Uzo and Garuba would have gotten nothing since they left within one year of the formation of the business. (Remember the one year cliff)
3. The third mistake made by Tope is not contacting a lawyer early enough.
Damage Control is very expensive, when it comes to the legal aspect of your business, prevention is always better than cure.
In as much as there are templates online that you can just download and use for your business, you cannot deny the place of actually contracting a lawyer to guide you through the entire process of the business formation and all you need to know regarding the legal aspect of your business.
In your attempt to minimise cost you end up becoming penny wise pound foolish when the consequences of your avoidable mistakes come knocking on your door.
So, I will like to ask;
Does your Co-founders or Shareholders Agreement have a share vesting schedule?
Do you even have a shareholders Agreement?
I hope you got value from this article?
Kindly use the comment section below to ask your question or contribution.