A dysfunctional board can limit your startup’s freedom of action. But dysfunctionality isn’t felt every day, but only in important matters.

Does the shareholders’ agreement matter for startups? No, if everything goes smoothly. Yes, if things don’t go well. And in a world dominated by unpredictability, expect things to go wrong. Therefore, yes, the shareholders’ agreement is important for startups.

I am a proud engineer, and I am known for my love-hate relationship with lawyers. Nevertheless, a good shareholder’s agreement can save you a lot of trouble in dire times.

In all those years at the helm of Yonder, a B2B company I co-founded, I had to resort to the shareholders’ agreement only twice: When I had to fire a co-founder and when discussing board composition.

Let’s look into the board composition in more detail.

Phase 1: Seed Round

When we closed our seed round back in 2019, we were young and inexperienced. But we had the luxury of a trustworthy, experienced lead investor. Therefore, we gladly accepted their suggestion for the shareholders’ agreement.

Regarding board composition, the initial shareholder’s agreement read the following paragraph (it’s very untypical for my articles to contain legal lingo!):

The Board shall comprise a maximum of 5 Directors. Throughout the term of this Agreement:

  1. the Seed Investors shall have the right to be represented on the Board by 2 Directors nominated by the simple majority of the voting rights represented by the Seed Investors (each a “Seed Investor Director”); one of the Seed Investor Directors shall be nominated by the Seed Investor 1;
  2. the Founders shall each have the right to be represented on the Board by 2 Directors (each a “Founder Director”). Initially, this shall be Founder 1 and Founder 2; and
  3. the Board shall, upon its discretion, appoint 1 director from time to time (each an “Independent Director”).

What happened after the seed round was closed? The board consisted of 1 Seed Investor Director, 2 Founder Directors, and 1 Independent Director.

The fifth director? Missed in action. It was probably due to our inexperience that we didn’t insist on having a second Seed Investor Director on the board.

Phase 2: Series A

In 2022, our Series A followed, and with it, a new lead investor joined the team. Of course, they wanted to have a board seat. We adapted the existing shareholders’ agreement with the inputs from our new lead investor, and now the board composition article read as follows:

The Board shall comprise a maximum of 5 Directors. Throughout the term of this Agreement:

  1. the Series A Investor 1 shall have the right to be represented on the Board by 1 Director (“Series A Investor Director”);
  2. the Seed Investors shall have the right to be represented on the Board by 1 Director nominated by the simple majority of the voting rights represented by the Seed Investors (each a “Seed Investor Director”; collectively with the Series A Investor Director each an “Investor Director” and collectively the “Investor Directors”);
  3. the Founders shall have the right to be represented on the Board by 2 Directors, nominated by the simple majority of the voting rights represented by the Founders (each a “Founder Director”); and
  4. the Board shall, upon its discretion, appoint 1 director from time to time (each an “Independent Director”).

Believe it or not, but the new lead investor didn’t nominate an Investment Director. They delegated a board observer, but when it came down to votes, they couldn’t make decisions.

Phase 3: The Deadlock

The shareholders’ agreement paragraphs discussed above mention a right to be represented on the board, not an obligation. So why do I speak of a deadlock?

There is another paragraph in the shareholders’ agreement that mentions important board matters; for example, approval of the budget, appointment and removal of the CEO, or the sale of the company.

For these important board matters, it’s not enough to have the consent of the majority of the board members alone; they also need the consent of at least one Investor Director.

See the problem now? If there is only one Investor Director, even though the shareholders’ agreement foresees two Investor Directors, the sole Investor Director enjoys a de facto veto over important board matters. And that is in a company that is still founder-controlled, meaning the founders hold more than 50% of all the shares.

Phase 4: The Cure

It’s normal to disagree from time to time, but in democratic Switzerland, we cherish limited power and balanced decisions.

We experienced a situation of disagreement over an important board matter decision. The appointed Investor Director had a different opinion from the other institutional investors, but they weren’t represented on the board at that time. This created a deadlock for the company, costing me lots of time, nerves, and energy.

That’s why I had to throw all my dominance into the battle to get that second Investor Director appointed to avoid similar situations in the future.

This happened 10 years after the incorporation of our company, and 3 years after the Series A.

Better late than never.