Employee and investor participation
Having a good business idea is always step one. To convert that idea into a successful and commercially viable company is step two and can be a difficult journey, which usually requires the assistance of third parties to complement your own skills in operating the business. Given the fact that the financial resources usually are limited when starting out and the engaged third parties will likely not be based on altruism, you will need to figure out a way to remunerate them for their services. This could either be done by convincing investors to provide funding, or by finding an alternative way of remuneration for the involved third parties. Either way, you will often have to decide on parting with a percentage of your ownership in the company in order to obtain funding and/or services from third parties.
Issuing additional shares
By issuing addition shares in the company which are paid for by an investor, a capital injection can be achieved which can be used for the further development of the business and for paying out third parties providing services to the company. As a general rule, the larger the investment, the higher the percentage and influence in the company the investor will demand in exchange for funding. By issuing the new shares, you will of course dilute which results in less influence in the company (for instance restricting your options to issue shares to additional investors) and a lower share in the eventual profits of your company.
Shares can of course also be issued to third parties providing services as a payment in kind instead of salary. This will likely involve less parting with influence and can have the benefit of obtaining commitment from the third parties providing services, since their valuable work for the company will benefit the value of their shares directly.
Either way, parting with actual shares however means you will be limited in your freedom of movement as a founder of the company. Luckily, there are alternative ways of participation that can be offered. These will likely not be acceptable to bigger investors since those will usually demand actual influence in the company, but for employees, service providers and smaller investors they may be mutually beneficial.
Shares without voting rights and share certificates
Since the implementation of new legislation in 2012, in the Netherlands it is possible to issue shares without voting rights. This entails that the usual influence attributed to shares is not granted to the holders of the shares without voting rights, which means the freedom of the founders to determine the course of the company is still intact. However, the holders of shares without voting rights still receive certain rights, such as to be invited to and attend all shareholders meetings. This can delay the decision making process in the company and therefore be disadvantageous.
In order to avoid such influence, as an alternative to shares without voting rights share certificates can be issued to the third parties. This entails that shares are issued to a foundation which holds the shares, and such foundation will in turn issue certificates in respect of the shares to the third parties. You can tailor the rights attributed to such shares to your liking, but usually only the financial rights connected to the shares are also connected to the share certificates, and all other rights are not. This means that the share certificates provide the holder with all financial advantages of actual shares, without any influence in the company.
Convertible loan
Instead of issuing shares a convertible loan can be granted (either by an investor or by a service provider, in which case the salary entitlement is converted into a loan). A convertible loan is increasingly used in financing startups. The loan can be repaid within a certain period, of course with an interest. The investor or the startup (depending on what is agreed upon) can however also convert the loan, usually at a predetermined time or upon occurrence of certain events, into shares or share certificates. By using the convertible loan the costs of issuing shares or share certificates are delayed until the moment of conversion. Moreover, the moment of determining the value of the company and the percentage the grantor of the loan will acquire is delayed until a moment upon which it is (i) likely easier to determine the value of the company given the progress then made and (ii) the value of the shares will likely be higher, meaning that upon conversion the percentage of shares (or certificates) you will have to part with in the company is likely lower then when starting out.
Profit rights
A final option to reward third parties is by offering them profit rights in one form or another. This can be done by way of stock appreciation rights, entailing that profits attributed to a certain number of shares are promised to the holders of such rights. You could therewith achieve that your influence in the company remains the same, but that in the event of dividend payments and/or a transfer of your shares, part of the profits achieved therewith need to be paid to the third parties holding the profit rights.
All of the above options have advantages and disadvantages that should be taken into account and obviously the right option for you depends on your specific situation. We would be more than happy to help you with a tailor made solution for your company.
Should you have any questions with regard to the above, please do not hesitate to contact the Startup Team.
