In the early stages of a startup, founders often issue equity to friends, family members and other investors to acquire initial working capital and to engage key employees at a low-cost basis.
When issuing equity in the early stages of a startup, it is important for founders to consider issues that will affect future stages of their startup’s business, including future financial needs. Obtaining the approval of minority shareholders for a financing or reorganization of a startup can prove challenging.
A voting trust is a method of ensuring a certain amount of control over the voting rights attached to certain shares. In this post, we discusses why some startups might benefit from having a voting trust in place among some of its shareholders.
What is a Voting Trust?
A voting trust is a trust arrangement among certain shareholders of a company, whereby such shareholders agree to vote their shares on certain matters in a particular way. A voting trust is often created by written agreement among certain shareholders and a person acting as trustee (i.e. the person who agrees to vote and act on behalf of those shareholders with respect to the shares and matters set out in such voting trust). A voting trust is often coupled with a power of attorney granted by each shareholder authorizing the trustee to execute certain documents on behalf of such shareholders.
Voting trusts are typically used to combine the voting rights of a group of individual minority shareholders, and to place decision making authority in the hands of a founder (acting as trustee of such trust) or another individual with a close understanding of the practical needs of the startup’s business. Other forms of voting trusts can be found in shareholders agreements, powers of attorney and dual-class share structures.
Why Your Startup Might Benefit
The main benefit of a voting trust arrangement is that it provides founders/directors of a startup with certainty that certain business decisions will receive shareholder approval. When a startup has multiple minority shareholders, decisions which often require shareholder approval (e.g. debt financing, granting security over the assets of the startup, the issuance of equity and a corporate reorganization) will not necessarily be guaranteed. This can lead to uncertainty, delays and increased costs in completing a financing or major transaction.
By combining the voting rights of a group of minority shareholders through a voting trust, such uncertainty is avoided. The power to guide key business decisions remains in the hands of those who have the best understanding of the needs of the company, and this helps startup founders protect the future trajectory of their startup.
A voting trust allows founders to leverage their startup’s equity to pursue growth and business opportunities without having to worry about obtaining shareholder approval, as such approval could already be guaranteed.
A voting trust can be useful in establishing an equity structure that will be attractive to potential investors. Ensuring that minority shareholders will vote with the large shareholders eliminates uncertainty and potential obstacles when a startup is looking to secure financing from venture capitalists or other private equity.
Voting trusts are often used where shares have been issued to friends or family members (perhaps through the “friends and family round” of equity financing) who have a limited interest or capacity in participating in the business.
Issues to Consider
Voting trusts are most effective when a startup has a properly-drafted shareholders agreement in place setting out the specific matters for which shareholder approval is required. Expert legal counsel should be consulted to assist in establishing a voting trust.