The important district court ruling re Ben Abu was recently published. The ruling deals with the three founders of Cyvera, a startup in the cyber field. Upon the company’s foundation, each founder was issued an identical number of shares. In two separate dates, in the beginning and the middle of 2013, one of the founders waives most of his shares in the company. The company was sold in 2014 for about $200M.
As part of the exit, the same founder sold his remaining shares in the company for approximately $2.5M and signed another waiver. After about a year, such founder sued the other founders for the shares he waived. The defendants claimed that the waivers were agreed due to the plaintiff’s deficient functioning in the company. The court resolved that the other founders exploited the plaintiff and accepted the suit.
Startups & Legal Certainty
In my eyes, as one who engages with startups on a daily basis, the court uses too broadly the exploitation cause. Since startups depend on a continues basis on venture capital investors and aspire an exit, they are at all times under a magnifying glass. Thus, the company legal status is most important. Therefore, in this world, legal stability and certainty are critical.
Even looking at “justice” in the particular case, which the court advances, this is a plaintiff that decided to sign important waivers, probably without investigation and consultation. Conduct that, in a field where legal stability is critical, should not be encouraged. Thus, it is doubtful whether this is the case justifying the use of the abstract exploitation cause, which is very rare.
The court relies on the plaintiff being in extreme distress, when providing the waivers. However, the court does not explain what the distress was. Actually, the court disregards, to a large extent, that the plaintiff signed very clear waiver documents, on several separate occasions, when the value of the shares was most evident to him.
Other Hitech Instry Concepts
Reverse vesting agreements, which enable the company to reacquire shares of a founder in a startup, are industry standard. Such agreements reflect the common concept that at least part of a founder’s shares in a startup are subject to his efforts and performance after incorporation. The court rejects such claim of the defendants due to the plaintiff being the investor of the company’s product. I believe such fact does not rule out the aforesaid concept.
In addition, the court analysis business situation retrospectively. It seems the court denounces the other founders statement that without the plaintiff’s waiver of his shares, it would be difficult of the company to raise capital and grow. Hitech investors regard shares of a founder who is not functioning as “wasted” since they do not incentivize effort, and generally such a founder who holds a significant stake in the company certainly deters investors. The founders team is considered the venture’s heart.
Further, the value of shares in a startup, as long as it does not exit, is, to a large extent, artificial. Thus, the courts expectation that the other founders should have volunteered to pay the value of the shares to the plaintiff is not necessarily realistic. Even if the court ruling in such respect is acceptable, it is not clear why the compensation to the plaintiff is derived from the value upon exit and not when the company acquired the shares from the plaintiff.
Inefficient Practical Results
The ruling may deter investors from startups that reacquired founder shares. Startups mat be deterred from conducting such reacquisitions. This may result in unfair allocation of shares between founders and harm the development of startups in which this issue raises. And there many cases of this sort. Additionally, the ruling may result in a deeper review of the reverse vesting agreements. The discussion will be around a broader definition of founder conduct allowing repurchase of his shares for not consideration. Moreover, waiver writs may be replaced by documents that implement reverse vesting agreements, while inserting a section stating company counsel represents the company only etc.
A Henrew version was published by Calacalist – https://www.calcalist.co.il/local/articles/0,7340,L-3768752,00.html
See also an article with TheMarker for which I was interviwed in this respect – https://www.themarker.com/technation/.premium-1.7694731 ,