Can fund my own startup in return for equity if that dilutes ex-cofounders?


1

My biz partner and I split up (not amicably) a couple of months ago, and he left my bootstrapped startup business. When he left, his total equity in the company was vested up to 20%. I own the other 80% and have continued working on the business. As part of the settlement agreement he insisted on getting back the money he had loaned to the company ($10k). However, now that the time has come to make one of the repayments we agreed on, there's not enough money in the company's bank account to be able to do this without putting the operations (and continuation of the business) at risk.

It seems like I have various options:
- simply tell my ex-partner the company doesn't have the money and ask for a delay of payment (which I expect may get nasty with him threatening to take legal action)
- attract outside capital (either as a loan, convertible debt, or straight equity deal) to be able to make the repayments
- put additional money into the company as a loan
- buy shares in my own company for more equity

I'm leaning towards the last option as the simplest and most attractive option for me. I have some money but it's a significant financial risk for me, hence I think getting extra equity in return would be fair. (my ex-partner, on the other hand, just wants to reduce his risk and take his money out).

I understand that there are legal protections against diluting an (ex)co-founder by self-assigning shares, but does this also apply if I purchase my own company's stock? If I, after this co-founder's departure, have to cough up more money and take on more financial risk to keep the company afloat, it seems reasonable that I could invest in my own startup and take more equity in return for having more skin in the game.
Practically, this may not be that hard to do, since him and I are the only shareholders, there's little revenue or traction so the share price is largely arbitrary. So I could assign myself a chunk of extra equity at a low valuation.

My intent is not to screw my ex biz partner. He deserves his money back when the company can afford to pay him. But I do feel that getting more equity for putting more of my retirement's savings on the line would be reasonable. Plus, if instead I do an equity financing with a 3rd party there'd be dilution for him as well (though also for me, in that case).

Is this tricky legally? Can I fund my own startup in return for more equity, without having to worry about getting sued by my ex-cofounder?

Co-Founder Equity Legal Investment Loan

asked Jun 5 '13 at 07:58
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John B.
6 points
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5 Answers


1

Short answer: You need a lawyer. Long answer:

In general, everything you do that is in agreement with ex-co-founder (and all other shareholders, if any) will be ok,

BUT

  1. In case someone changes his/her mind later you could be in trouble unless everything is covered in a contract or other proper legal documents
  2. If you can't reach an agreement you'll need a lawyer to tell you what you can or can't do
I am not a lawyer, this is not legal advice, even if it was you shouldn't take legal advice from random people on the internet, you should really talk to a lawyer.
answered Jun 9 '13 at 19:35
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Nir
1,569 points

1

If the business has the cash to pay back the loan then do so.

If the business needs cash to pay off the loan or for operations after paying the debt, then you should loan the business the required cash. Just be sure to write an agreement between you and the company for repayment, and track the amount you put in as a loan (liability) not capital. You might even want to secure the loan with any tangible assets owned by the company and/or its IP.

Next, do everything you can to buy out the ex-partner. You don't want a negative person around, mucking up every deal you want to do, so get him out ASAP. Your shareholder agreement should outline how this is done. If you don't have one, then sit down with the other share holders right now, while the company is in debt,and worth nothing, and hammer one out.

If that fails, consider shutting down the business after you make the loan to repay the ex-partner. When a company is dissolved, loan holders get paid before stockholders, so if you wrote the loan agreement correct, you can walk away with 100% of the IP, and your ex-partner gets nothing since he wouldn't sign a shareholder agreement.

Once you decide what to do, hire a lawyer to do all the paperwork.

answered Jun 12 '13 at 05:02
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Tlueker
96 points

0

Do you have an LLC or a corporation? Is your entity a Delaware entity or a non-Delaware one?

If you have a corporation, please note that IN GENERAL minority equityholders' rights are more strongly enshrined in law; if you have an LLC, minority equityholders' rights are at least in Delaware just what your operating agreement says they are. So in short: if you have a corporation, think longer and harder about proceeding than if you have an LLC.

Also, what do the terms of your documents say? Can you issue shares to yourself without your minority equityholder's consent?

Why not just loan the money to the company in a transaction that's at arm's-length?

answered Jun 5 '13 at 09:02
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User6492
1,747 points

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I think the only way you can do that is to give a loan to your company in form of convertible debt, so it eighter pays it back, or gives shares based on the next investment round's valuation. But you cannot make up a valuation and give yourself shares based on that. I think that would be illegal, EVEN IF you have agreed, that the majority shareholder can do whatever he wants to.

answered Jun 5 '13 at 09:19
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Jani Kovacs
75 points

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You need to think beyond the current transaction to all transactions to ensure that whatever you do doesn't require a new round to meet you future obligations.

Perhaps you can offer a smaller amount to the ex now, but explain the company will likely fold if I give the full amount. Put that in writing.

If he tries to sue, he will look very bad if he was told demanding the full amount jepordizes future amounts ... As compared to getting a smaller amount now. Now demonstrates a commitment and acknowledgement of your obligations rather than hiding from them. That makes you look good.

Don't add more of you own money to the business, that just increases your risks.

I'd seriously, consult a lawyer, advice from here could be totally wrong for your jurisdiction.

answered Jun 6 '13 at 20:50
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Elenesski
100 points

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