Startup Law: Handy Legal Term Explainer

Acting in Concert

When parties work together to spread ownership percentage of shares in a company by making identical investment decisions. This is usually done so that an individual can avoid having to declare takeover intentions or placing of a tender offer or so that parties can, possibly covertly, influence decision-making in a company.

Anti-dilution Shares

Shares with a form of anti-dilution provision.

Anti-dilution provision

A provision that may be taken to avoid the negative repercussions (for investors) of dilution during a down round. This commonly takes the form of either a Full Ratchet or Weighted Average provision.

The Full Ratchet method increases the number of shares owned by investors so their percentage ownership of the company remains the same. This is advantageous for investors as they maintain any voting rights that they held before the increase of outstanding shares. This provision is rarely used as it can be dilutive to founders and it discourages follow-on investors.

The more common provision is the broad-based weighted average method. This follows a complex formula which reprices the shares of the Series A investors based on all of the equity previously issued and being issued to the Series B investors. This is the most favourable option for founders because it results in a higher conversion price for the investors.

Articles of Association

A document that acts as a company’s constitution, dictating the various regulations within the company, the roles of directors, and other rules of the company.

Associate

A fancy word for a co-worker or co-investor.

Auditors

People employed to track and document the cash flow of a company. Also known as suits.

Available Profits

The amount of a company’s profit that is available to pay as dividends to shareholders.

B Ordinary Share

Similar to an Ordinary share in a company, but often without the voting or dividend rights that ordinary shares would typically have. Because B Ordinary shares don’t have voting rights, it’s often convenient to give them to employees for their vested stock options, as it saves having to chase up dozens or hundreds of ex-employees every time a shareholder vote is needed, leaving only a much smaller admin overhead to round up the small number of shareholders with voting rights.

Bad Leaver

A person who ceases to be an employee of a company, whose circumstances of leaving are not covered by the ‘good leaver’ provisions e.g. due to gross negligence or misconduct. Bad leavers will often receive a heavily discounted price for their shares on exiting the company.

Board

The Board or Board of Directors are the individuals elected to represent the interests of the shareholders during decision-making on major company issues.

Bonus Issue

An issue of additional shares to shareholders, instead of a dividend, in proportion to the shares already held.

Chairman

An executive, elected by members of the Board of Directors, responsible for ensuring that meetings remain orderly and reach conclusions. In smaller companies this is often combined with the role of the CEO, though that can undermine the system of checks-and-balances that having two separate people ensures.

Commencement Date

The date on which the actions pertaining to a contract begin.

Company lien

A company lien on a share means that a member of a company is not permitted to transfer their shares until they have paid their debts and liabilities to said company. Although this is not an inherent right, it is nearly always provided as standard in the articles of incorporation.

Controlling Interest

A person has a controlling interest when they own a majority (in most cases over 50%) of a company’s stock.

Co-sale rights

These give the minority shareholders the right to sell their stake in a company if a majority shareholder sells their shares, for the same price. This means that minority shareholders may be able to exploit the potentially higher price that majority shareholders can leverage. This is most likely to be beneficial when an investor/VC has invested enough to have a controlling interest.

CTA 2010

Corporation Tax Act 2010. A reliable pickup subject at parties.

Deferred Shares

Although no longer commonly used, these shares can provide their owners with higher dividends, but they are only paid either once holders of all other classes of shares have been paid or after a set date. Often these shares do not carry voting rights. However, in modern usage, the rights of these shares are often deliberately restricted to the point of being worthless, as a means of carrying out capital restructuring.

Dilution

When a company requires additional capital and sells more shares, this creates a dilution effect. This occurs because the value of each share, as a percentage of the company, is decreased. Dilution can also occur when stock options are exercised.

Director(s)

A member of the board of directors. Their powers are derived from both the company’s Articles of Association and general corporate legislation. A director is both a company agent and a trustee, and thus may be sued by the stockholders for the consequences of fraudulent or negligent acts.

Dividend

A proportion of a company’s profit paid to shareholders. The amount is decided by the board of directors and is paid in accordance to the number and class of shares held by the shareholders. Most start-ups choose to not offer dividends and instead use that money to sustain their growth.

Down round

The sale of securities at a lower value than during the previous funding round. Generally, shares issued in new funding rounds will be at a higher valuation. Down rounds generally occur when a company is failing and needs to raise capital. However, venture capital firms can force down rounds to occur in order to cause dilution, thus increasing their influence and decreasing the influence of the founders in the decision-making process. This may allow them to buy large numbers of shares which could carry voting rights.

Drag-along right

Designed to protect the majority shareholder, and usually terminated prior to the IPO, the right enables the majority shareholder to force the sale of stocks by the minority shareholders when they sell their own shares.

Employee Trust

A trust fund established by an employer, set up to hold cash and other assets, like shares, to provide benefits to employees.

Equity Securities

Instruments that represent a right to equity in a corporation, and thus a claim to a proportion of its assets and profits based on the number of shares owned.

Equity Shares

Often just called a stock or share, an equity share represents a percentage ownership of a company and entitles the holder to voting rights.

Founders

The entrepreneurs who started a business. They usually also have executive positions (CEO, CTO) but that doesn’t have to be the case. Founding CEOs in particular are rarely the right people to still be CEO when the company morphs from a startup to a large enterprise, leading to the founding CEOs often being forced out (they lose their CEO and director position, but still retain Founder status).

Good Leaver

A person who exits the company (usually) due to involuntary reasons e.g. becomes incapacitated, is made redundant or dies. The conditions of being a good leaver are sometimes left to the discretion of the Board. Good leavers will usually receive full open market value for their shares on exit.

Holding Company

A company with controlling interest in another company (the subsidiary company). Holding companies usually exist for this sole purpose as they limit the liability of the individuals who own the large number of shares in the subsidiary company.

Institutional Investor

An entity that pools money from multiple investors in order to purchase large numbers of shares in companies.

IPO

Initial Public Offering, the first time that a private company offers shares to the public. Usually the opportunity for the founders and early investors cash in. Or cash out.

ITEPA

UK Income Tax Earnings And Pensions Act 2003. Riveting stuff.

Issue Price

The price of a share when it is first offered.

New Securities

A security is a stock, bond or option.

Ordinary Shares

Also known as Common shares, Ordinary Shares are a basic share in a company that (usually) entitles the owner to one vote per share and to an equity ownership in a company proportional to the number of other shares. Prior to IPO In start-ups, ordinary shares are generally only held by founders and employees, however, in some cases, Angel investors may hold ordinary shares. Later stage investors usually angle for and get Preference Shares.

Pari Passu

When multiple assets, obligations, contracts etc. are treated equally, without any preference.

Pre-emption rights

The right of existing shareholders to purchase newly available shares prior to public offering. This can be exploited by shareholders to prevent stock dilution.

Preference Dividend

A dividend paid on preferred shares. Usually paid before any dividend on common shares.

Preferred Shares

A preferred share has a higher claim on company assets and earnings than common or ordinary shares. Preferred shares generally have a dividend that gets paid out before dividends to common shareholders. Preferred Shares often don’t carry voting rights.

Pre-New Money Valuation

The value of the company before any new cash is invested. It’s important to get on top of Pre- and Post-money valuations for your company before meeting potential investors, these numbers should roll of your tongue as if you’re an old hand at this.

Pro rata

Proportional allocation.

Restricted Shares

Also known as restricted stock units, restricted shares are a share that is not transferable until certain conditions are met such as a length of time expiring or an IPO. They are usually given to executives as an alternative to stock options due to favourable income tax treatment.

Series A Shares

The shares sold during the first round of major investment. It will often have different benefits to series B, C, D, etc. shares. Series A funding is typically the level at which VCs get involved with the company,  they generally invest in exchange for a 10%-30% stake in the company, most commonly in the form of preferred stocks.

Series B Shares

Shares sold during Series B funding. This funding round generally involves larger investments than in the A round, where investors are looking for the company to be growing and gaining traction. Hence, B round funding is seen as lower risk, justifying the larger investments.

Special Dividend

A distribution, usually of cash, to shareholders, that is most often declared after a period of exceptional company earnings. It is a method used to distribute profits directly to shareholders.

Tender offer

An offer to purchase shares from a shareholder, usually at a premium to the market price, as an incentive to sell their shares. This is a method of executing a hostile takeover.

Treasury Shares

A portion of a company’s shares that are kept in its kitty for use when in need of extra cash, and to prevent hostile takeovers.

Trustee

An individual who holds assets for another person (the beneficiary).

Unvested

Unvested stocks are shares promised to an individual, but are not fully owned (vested) until certain conditions are met. Often applies to stock options given to employees, where the options vest in monthly or quarterly tranches over a period of 3-5 years.

Voting Rights

Voting rights are given by certain shares and guarantee the ability to vote in general meetings. This allows the shareholders to have a say in the running of the company, and gives them the ability to vote-out a poorly performing director.

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