Business Start Ups- Some Key Words to Learn
Before entering into an equity business arrangement with another party (usually by way of a shareholders’ agreement) it is important to know the meaning of a few key terms in order to understand some of the primary legal considerations for start-up ventures.
Drag- Along Rights: in the event of a proposed sale by a shareholder, drag-along rights give the selling shareholder the right to force the non-selling shareholders to also sell to the proposed purchaser. This provision is designed to ensure that the major shareholders can’t be blocked from exiting by minority shareholders.
Due Diligence: when someone is considering investing in your start-up or buying your business from you, if they are prudent, they will conduct investigations into all aspects of your business, including the legal terms of your key commercial contracts as well as your compliance with legal and regulatory requirements. If purchasers perform due diligence, you should perform your own due diligence on your business idea before committing funds to it.
Employee Options: this option gives the employee the tight to acquire a share in the company. This can be a right to purchase a share or receive the share for free. Usually, employee options only “vest” (i.e. become exercisable) if certain performance targets are met. Options are important to conserve start-up capital and align incentives.
Pre-Emption Rights: These rights are also called, “rights of first refusal” and are rights that entitle the existing shareholders to receive and offer of securities first before those securities can be offered to third parties. This may relate to shares that one of the existing shareholders wants to sell, or new shares that the company to issue to raise additional capital.
Tag- Long Rights: In the event of a proposed sale by a shareholder, tag-along rights give the non-selling shareholders to right to sell alongside the selling shareholder (i.e. the selling shareholder can’t complete its sale unless the proposed purchaser also offers to buy out the tagging shareholders, as well). This is designed to give minority shareholders the ability to sell into the same exit as the major shareholder.
Tax Deferral: Employees may receive employee options as part of their remuneration structure. Options have a value and, unless the option plan is properly structured, the employees could be liable to pay income tax on the value of the options in the year in which they are granted. “Tax deferral” refers to deferring payment of tax on the options, until a later time (e.g. when the company is sold).