By: Alyssa Ziegenhorn
You had a great idea, and you’ve just started your company – congratulations! At this early stage, the company is most likely just you and a few close friends or relatives. Without a large roster of executives, employees, and investors to keep track of, you might think that it isn’t necessary to document your company’s stock ownership with a stock purchase agreement. After all, you and your sibling/college roommate/spouse are the only owners of the business. It’s obvious who owns the shares.
Or is it? Often founders of early-stage companies don’t feel it necessary to execute stock purchase agreements between themselves and the company. As sensible as this may feel at the time – you’re saving time and legal expenses, and reducing unnecessary documentation! – it can cause significant issues later on.
Ambiguity on ownership and decision-making
If the company has multiple founders or owners, not executing stock purchase agreements can make it unclear who has decision-making power. Is the ownership 50/50, or 49/51? If there is a disagreement down the road, it can be difficult to prove decisively what the ownership split was at the beginning of the company, especially if significant time has passed.
Issues with future investors
If things are going well, your company might attract investors. That’s great! But part of landing an investor is due diligence – they’re going to want to see all the company’s records. If there is no documented stock purchase for the founders, investor confidence in your project may decrease. Having proper documentation from the beginning makes your company look more professional and increases confidence in your future success.
Significantly increased legal costs
Say you end up in the scenario from #2, and you need to get your documents in order for potential investors – fast! You can hire a law firm to help with that, but diving into old documents and records takes time. It might also involve tracking down old founders or employees who are no longer with the company and getting them to execute documents retroactively. This can be time-consuming and difficult, especially if the relationship with former co-founders or advisors has become negative. All of this means you are looking at significant legal costs; much higher than they would be to execute the agreements at the start.
Increased tax burden on future shares (no backdating)
If you do need to execute stock agreements later on, it can also increase the tax burden for whoever receives the shares. Backdating stock agreements is strictly against the law. If you execute agreements for your company that was formed five years ago, the effective date has to be the date they are signed. That means if the value of your company shares has gone up, perhaps due to investor interest or successful revenue years, you are going to be responsible for the value of the shares at the time of the agreement – not the time of the company formation.
For all of these reasons, executing stock agreements at the time of formation is a crucial step to set your company up for success, whether you are a small business or an early-stage startup. For more information or help with your company formation, please contact us at info@bendlawoffice.com.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.