Legal counsel plays a pivotal role in structuring deals that align with the strategic goals of both startups and investors. Lawyers craft and review the essential documents needed to execute funding rounds, scrutinize terms and conditions, and anticipate potential legal complications before they arise.

Comprehensive due diligence is a lawyer’s forte, safeguarding investors from unforeseen liabilities. They meticulously investigate a startup’s legal standings, past contracts, compliance with regulations, and any potential litigation risks.

Lawyers are instrumental in devising effective legal strategies that not only secure capital but also protect it. From crafting shareholder agreements to advising on the most suitable funding instruments, they ensure that capital infusion is both legally sound and strategically advantageous.

• Lawyers are key in outlining investment terms that protect venture capitalists’ interests.
• They analyze and mitigate risks associated with startup funding.
• Counsel ensures compliance with the latest financial and securities regulations during the investment process.

Congratulations! You’ve just founded a new company! You now own 100% of the shares in your new venture. But, what happens if you want to bring in a co-founder and/or a VC, both of whom will want part of your 100% stake? Well, you’re going to need either a founders’ agreement or funding agreement of some sort, and that’s where a tiebreaker clause becomes essentially important.

Let’s start off simply by saying that Casey founds “Widget Corp, LLC.” Casey then meets Sam through some business contacts and they decide to become co-founders with a 50/50 split in the company. They decide to sign a simple, one page agreement they randomly found online that just says they’re splitting the equity in Widget Corp 50/50 without any other details.

Everything sounds great, right? The founders are on an equal footing, have a great relationship, and are excited to launch their new venture. What could possibly go wrong? Oh, so many things. A lawyer’s job is to see all of those possible issues and draft the contract in such a way that it clearly details how to deal with that potential problem long before it arises.

Let’s fast forward two years. Widget Corp is doing great! It now has a Market Capitalization of $5 million and is projected to have a market cap of $10 million in year three, and $15 million in year four, with no end to the growth after that. Casey and Sam are starting to hope that they might have one of the elusive “unicorns” on their hands.

However, in July of year two, Casey and Sam have a disagreement that they just cannot agree on. For example, Casey and Sam need a new distributor to support their growth. After investigating a number of distributors, they’ve settled on two finals choices: Distributor A and Distributor B. Sam wants to go with Distributor A and loathes Distributor B. However, in direct contrast to Sam, Casey absolutely can’t stand Distributor A, and wants to go with Distributor B.

They have been fighting about this pretty much non-stop since March. At this point, it’s pretty clear that being stuck with their old distributor and the constant fighting are both seriously hurting Widget Corp’s business. Something needs to be done. But, they just cannot agree on which distributor to use. And…this is where the problem arises. Because Casey and Sam are 50/50 owners of the company neither of them can outvote the other one, so they will be stuck at a perpetual impasse unless one of them somehow manages to win the argument, which isn’t likely. At this point, Sam and Casey only have two terrible options: 1) File a lawsuit so a judge can break the tie or 2) dissolve the company entirely.

Filing a lawsuit will not only prolong the delay that’s already hurting the company, but it will also likely both cost the company tens or hundreds of thousands of dollars in legal fees and lead Casey and Sam to become even more entrenched in their positions. Regardless of who eventually wins the lawsuit, the likely result will be that the loser will be bitter and resentful of the other party, and, in all likelihood, they will end up having to split up as co-founders before long.

Dissolving the company is obviously a disastrous “solution” because, not only does the company no longer exist, but there could be other lawsuits, costs, etc., involved with wrapping up the company.

Either way, those projects Casey and Sam were hoping for and their aspirations to become a unicorn? Those are gone.

By the way, lest you think this will never happen to you, the reason I can say with confidence that these are your two options is that this exact scenario has been the basis for countless real lawsuits with real founders who never thought who also never thought they would ever be in this situation either.

What if Casey and Sam had initially split it 51% Casey/49% Sam? Wouldn’t that avoid the mess above? Sure, in theory. However, because there are only two parties and Casey has 2% more of the votes than Sam, Casey will always be able to outvote Sam. So, even though Casey and Sam seem like they’re on equal footing, because Casey can always outvote Sam, for the purposes of voting rights, 51%/49% is indistinguishable from 60%/40%, 80%/20%, or even, 99%/1%. The result being that, once Casey outvotes Sam a few times, even if it’s over something small, over time, Sam will likely become bitter and resentful, again resulting in a breakdown of their relationship and the likely destruction of the company.

This is where a tiebreaker clause comes in: it lays out exactly what should happen if a company’s shareholders both can’t outvote and cannot agree. Because a tiebreaker clause is just a general idea, there are any number of methods for setting it up, depending on what the founders want. For example, the clause could specify that, if, after 30 days, the founders cannot agree, then a specified third-party is empowered to break the tie. Let’s go back to Casey and Sam for a moment. Remember how they initially met through a mutual business contact? Let’s say that business contact is named Alex, and both Casey and Sam deeply respect Alex’s opinion.

If Alex is willing, Casey and Sam can specify in their Founders’ Agreement that, after a specified period of disagreement, Alex can break any ties like the Distributor A v B issue discussed above.

That way, rather having to file a lawsuit or dissolve the company, they can just ask Alex to resolve the dispute. And now, rather than bitterness, delays, and virtually inevitable breaking up, Casey and Sam can quickly resolve the issue and get back to developing their unicorn, ready to face another day!

This whole scenario is predicated on the assumption that Casey and Sam were able to entirely fund Widget Corp without giving away any additional equity to an outside entity like a VC.

Needless to say, this is not a common or typical scenario. Would adding in a VC or other founder solve the tiebreaker problem? Not really. In fact, depending on the founders’ perspectives, it might even be worse.

So, let’s rewind to when Sam and Casey first met. Instead of immediately launching Widget Corp after they meet, they decide to give 20% of the stake in their company to Seed VC for a seed round investment. Let’s assume that Sam and Casey both give up 10% of their equity to make up the 20% they’re jointly giving to the VC. So, after this initial seed funding round, the equity split is 40% Sam, 40% Casey, and 20% Seed VC.

Ok, now let’s fast forward to again to where Sam and Casey are having the same intractable Distributor A/B disagreement. How does the addition of the VC’s 20% change things? Because there’s now a third party that also owns a percentage of the company, i.e. the VC, they become the judge/tie breaker by default. In this case, because Seed Legal owns 20% of the equity, they will automatically be the tie breaker. Depending on the relationship between the VC and the company, having the VC be the default decision maker could range anywhere from a perfect solution to a complete and total disaster. Plus, it could also reflect poorly on the founders that the VC had to break the tie. Regardless, the ability to control what happens next is entirely out of Sam and Casey’s hands. And, in my experience, most founders dislike giving up any control over their company, especially when it’s a scenario like this where it’s neither necessarily beneficial for the company nor frees up space on the founders’ plates. So, once again, the solution is to have a tiebreaker clause in both the founders’ agreement and any fundraising agreement between Widget Co and Seed VC. That way, the founders can decide in advance how to deal with any disagreements well before something like the Distributor A/B disagreement arises.