I
n the early stages of a company’s life, issuing shares is a vital cog in the machine. When cash is scarce, having a pool of value that can be used, at very little cost to the company, to pay employees and even contractors is very attractive. Making employees into shareholders is also a powerful tool for incentivisation, as the value of the shares
that the employees hold will depend on the success of the company – so it gives those employees another good reason to contribute to the company’s success.
In line with its importance, making sure that this cog runs smoothly requires significant amounts of planning and preparation. Whether a sale or an IPO, problems with a company’s equity will usually cause significant problems for an exit transaction – and trying to rectify those problems in the middle of a process can be a costly business.
NonIssue Ltd.
In its early stages, NonIssue Ltd. kept things relatively informal. Rather than bringing in full-time employees, friends and contacts were engaged to do jobs for NonIssue as and when required – and some of them were offered equity as part of their payment.
The
founders of NonIssue duly kept a record of all of the shares that they had issued, and made all the necessary filings with Companies House.
Unfortunately, NonIssue had failed to check that they had satisfied all of the technicalities of issuing shares. The directors had assumed that they were able to allot and issue shares as and when they wished, but in fact share allotments required authority from the company’s shareholders and no such authority had ever been obtained.
This problem was not discovered until the investor putting up the majority of NonIssue’s B round funding brought in its legal advisers to conduct due diligence on NonIssue’s records prior to the investment round. NonIssue had never properly engaged with its own lawyers, to keep costs down, and even when an investor in the A round insisted on seeing a shareholders’ resolution authorising (among other things) the allotment of shares, the founders did not
realise that they had failed to do the same for their other issuances. Once the problem had been identified, the investor agreed to put off the B round for a couple of weeks and NonIssue spent a costly fortnight getting proper authorities and ensuring that the shares were properly issued.
This specific situation should not arise any more - under changes made by the Companies Act 2006, the directors of a private company with only one class of share capital can now issue shares without prior shareholder authority unless the company’s articles restrict them from doing so. That said, issuing shares in a company remains a process that requires various technical boxes to be ticked – and, if any are not, the issuance is void. Having to issue shares again, properly, will take time and far more cost than if the company had taken legal advice in the first place – particularly if there is a complication, such as a “shareholder” having sold on to a third party the shares that were never validly issued to them.
MindChange Ltd.
MindChange Ltd. was a start-up that was also using its equity as currency to help finance its development. The pace of MindChange’s development was quite rapid – so rapid, in fact, that while they had one particular friend of the business working on Project 1, the completion of Project 2 persuaded the directors to take MindChange in a slightly different direction. As a result Project 1 was no longer needed but, due to poor communication, the contractor remained unaware of Project 1’s cancellation.
There was no paper contract between MindChange and the contractor, but there were various email exchanges that pointed to a contractual relationship - and it was clear from the correspondence that if the contractor delivered Project 1 then he was entitled to a slice of MindChange’s equity. Accordingly the board of MindChange, with shareholder authority, resolved to allot and issue shares to the contractor.
Unfortunately, the contractor took personally the decision to change the focus of MindChange. When the board of MindChange remained set on their new
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