How to handle investors on your cap table

This article was first posted on Der Shing’s blog.

Over the years, in addition to running our own businesses, we have also invested in about 24-25 startups where Shao Ning & I play different roles. Board member, Advisor, Angel Investor, Syndicate Lead Investor, Joint Venture Investor and even chairman type investor. Two main factors are at play – the shareholding we own and the role we play for the startup.

We have also realized that different founders handle non full time shareholders very differently and the standards vary. Below are some guidelines on what we would think founders should consider and do for the various types of shareholders.

1) Key Mindset

The key mindset is that your shareholders are your supporters. Get to know each of their motivations for investing and also their strengths in terms of how they help you. Then make full use of it. Remember that most people prefer to be told what is happening and investors do expect startups to face lots of problems. So don’t avoid updating bad stuff or problems.

Of course, be prepared for all types of feedback and help. Some will be good, some not so good. But remember you are the boss. So don’t be afraid to ignore advice given but of course, you better hopefully be right to ignore the advice.

2) Compliance with all legal requirements

Management should always be clear on the company constitution and shareholder agreement terms. Should also ensure that all shareholder rights are complied with. Eg. if a mgmt decision requires a Board or Shareholder approval, it should be sought. An email explaining the reason for the action and also giving enough time to ask questions and approve. It is also helpful if the board has already agreed to the decision.

The other key factor here is information rights. AGMs, audited annual numbers are usually bare requirements which all shareholders should be privy to. Some shareholder agreements will require more regular updates and some state that board minutes must be shared. Make sure these are all done.

3) Regular updates (even if not legally required)

Depending on the role and shareholding, it is best practice to keep your shareholders updated on how the business is doing. It also depends on the understanding you have with each shareholder. By and large….

a) Monthly updates with commentary & P&L, Cash for all board members and lead investors in current round and maybe even past round lead. Likewise JV partners for sure will want this. Usually do not need to update individual smaller shareholders (own <5%) but you may want to send this update to shareholders who have demonstrated value to you via experience or contacts.

b) annual shareholder meetings and report. Does not hurt to write a longer commentary to summarise year and plans for next year and circulate to all shareholders. All shareholders will appreciate this rather than just a AGM and audited accounts. You can even host a simple gathering for shareholders annually.

3) Corporate Actions

This is trickier to do well. Founders must remember you wear 2 hats. One as mgmt and board director, another as shareholder. There are many types of corporate actions that i have seen being handled less than ideally. The key problem is usually lack of information and notice given. Then some smaller shareholders may feel being pressured or rushed or worse still being taken advantage of!

a) Share transfers/sale to 3rd party.

Once the company is notified of this, it should immediately act according to shareholder agreement and notify all shareholders of price and quantity if there are ROFR clauses. Also check if tag alongs will be triggered, if so shareholders should be notified not just about ROFR and prices, identity of buyer and seller but also reminded of their rights.

As a founder, you usually are not allowed to sell or tag, and your role is more to facilitate. It is usually helpful to state reason for sale and identity and intentions of the buyer.

Eg. founder parents selling part of stake to new or existing shareholder because they were earliest money and now need to retire.

b) New round of investment

Board will usually discuss and approve this activity, so major shareholders will know about this. Smaller shareholders should also be informed once a term sheet is signed. They should be aware of terms and also of their rights. Usually is pro-rata. It is best practice to share the terms and then ask each shareholder to reply if they intend to keep pro-rata.

The trickier part is here is how to handle terms which require old investors losing board seat and new share class having much superior rights to old share classes. You need legal advice for sure but you should also keep your old investors updated on all the “asks” by the potential investor. Some key areas of contention usually revolve around those where founders/mgmt are not so affected but older investors are disadvantaged.

– board seats & composition

– Redemption clauses for new investor

– Liquidity Preferences, Coupons which only accrue to new investor

– Any special rights (ROFR, Drag, even information) that accrue only to new investor

Be sensitive and never try to make your old investor feel you are so eager to do the deal and happy to ignore their rights. This is not only bad move (as they can probably block the deal) but also quite ungrateful to not consider your oldest supporters.

c) Sale of company

This is a happy event. Again once term sheet signed, all shareholders must be notified of price, buyer and intentions and timeline projected. Keep shareholders updated on the sale process. Eg. timelines, due dilligence etc. If you do close the sale, do remember to call each of them to thank them for support or hold a thank you session for everyone.

d) Closing down of company

Reverse of above point but it happens. Doing this well is also a mark of a good founder. If you have been updating shareholders, it will not come as a surprise. Share thinking, timeline and be open to shareholders suggesting ways to keep things afloat. Sometimes, a hail mary may appear and a shareholder finds a way to get more money in or even to sell the company.

This is a very tough thing to do. I find most founder run away and avoid shareholders. This kind of behavior is doubly wrong. Investors understand startups fail, so handle this episode well and depending on why startup failed, investors may still continue to support you. And plan finances properly so that the company can be closed down without debt. This is only ethical. It is morally wrong to continue to incur large costs when it is clear you are closing down.

4) Entanglement with govt, lawsuit

If the company has broken a law or is being sued, there is a responsibility to notify your board and act to remedy right away if it is with govt. Commercial lawsuits are a bit different and more nuanced as it it depends on whether the suit was frivolous or has merit.

5) What about confidentiality?

I know some startups are worried that their investors have similar investments or worse still are not ethical and share the data they send to competitors. This is very possible as there are all sorts of investors out there. There are a few ways to mitigate this.

a) Shareholders agreement should have confidentiality clause. So there is legal recourse if need be.

b) Send what they need to know. Its usually very top level financials and general commentary. You dont have to give any client names, contract sums or marketing/sales funnel details.

c) Don’t take money from possible competitors and don’t take money from VC who support multiple startups in same space and geography.

If you really have doubts about a shareholder, just revert back whatever legally required and dont share more.

I hope the above is useful to founders and management. There is a lot that can be improved in the area of communications and expectation setting. Please do feel free to add more to comments section.