336 ENTREPRENEURSHIP
This becomes a critical area of negotiation for the entrepreneur, especially when cheap shares of
common stock are offered to officers, directors, employees, and consultants, as is common in
start-up situations. A provision should be negotiated that these sales do not trigger the antidilu-
tion provisions.
Performance and forfeiture provisions call for the entrepreneurs to forfeit a portion (or all)
of their stock if the company does not achieve a specified level of performance. It protects the
investor from paying too much for the company in the event the entrepreneur’s original projec-
tions were too rosy. If the entrepreneur fails to meet the rosy projections, the entrepreneur pays
the price of reduced ownership in the company. Also, the forfeited stock can be resold to new
executives brought in to improve the firm’s performance. This provision motivates the entrepre-
neur and protects the investor.
In a start-up, a significant portion of the founder’s equity may be at risk due to the perform-
ance/forfeiture provision. As the company achieves its early goals, the entrepreneur should nego-
tiate less severe penalties and can legitimately negotiate removal of this clause because the firm’s
performance has shown that the initial valuation was reasonable. If the investors are reluctant to
give in on this, the entrepreneur should insist on bonus clauses for beating the projections. In
short, for each downside risk, the entrepreneur should negotiate for an upside reward.
Employment contracts motivate and discipline the top management team. They often pro-
tect investors from competing with the founders of the company if the founders are forced to
leave. All terms of the founders’ and top executives’ employment contracts (salary, bonuses,
fringe benefits, stock options, stock buyback provisions, non-competition clauses, conditions of
termination, and severance compensation) are negotiable. Investors want an employment con-
tract that protects their investment in the venture. Especially if investors are buying a controlling
interest in the company, the founder will want to negotiate a multiyear deal. The drawback to
multiyear contracts is that if the entrepreneur wishes to leave early to do other things, investors
can sue for breach of contract and/or prevent the entrepreneur from engaging in a competing
business.
Control issues are negotiable and are not dependent solely on the proportion of stock the
investors have purchased. All minority stockholders have rights. A nationally recognized
accounting firm will be hired to audit the financial statements, and important managerial posi-
tions may be filled with people recommended by the investors. All important business transac-
tions (mergers, acquisitions, asset liquidations, and additional stock sales) will require consulta-
tion and consent. The entrepreneur who accepts a minority interest after the investment should
negotiate for all the rights and options that an investor would.
Shareholder agreements are favored by investors to protect their stake in the company.
Shareholder agreements can bind the company when it offers new shares, forcing the firm to
offer the original investors rights of first refusal on the new shares. Sometimes agreements call
for the management to support the investors’ choices when electing board members. Although
these agreements are usually made at the insistence of the investor, entrepreneurs can ask for
equal power as they negotiate for their stake in the new venture.
Disclosure is the process by which entrepreneurs provide investors with the full and complete
details of the information and relationships under which the investor makes his or her decision.
The investor requires audited financial statements, tax returns, and assurance that the company
is in compliance with all laws and regulations.
Investors are especially concerned about contingent liabilities. Contingent liabilities arise