Thursday, May 26, 2011

Covenants

DSC04360We’re securing the last bits of money for CamStent, meeting with investors, listening to their concerns, and adapting our governance to protect everyone’s rights.  These debates about promises and covenants are the most difficult ongoing discussions ongoing: what is right, what is fair, what is legal, what is moral?  Two cases illustrate the dilemmas.

Small investors worry about dilution: the impact that larger investors can have on their percentage ownership of the company.  We limit the size of funding rounds to fix their percentage, and put in strong pre-emptive rights to assure that they can maintain their percentage stake despite subsequent fundraising rounds.

Sometimes, that is difficult.  With a third of our round left to go,  an investor appeared to offer double the amount remaining, significantly oversubscribing the round.  Its real money, hard to obtain and extremely valuable to us at this stage.  However, that oversubscription dilutes every other shareholder’s percentage by 10%.  There’s no legal barrier, but is it right to take everything offered when we said we’d stop well short of that?

I consulted with my Board- they unanimously said ‘go ahead’.  They did recommend that we revise the budget to assure that the additional investment generated true asset value by achieving some tangible milestones.  They also recommended that we notify all investors, offering the opportunity to ‘top up’ to their expected percentage.

Not perfect, but good enough: I took the decision to accept (if available) the oversubscription.

Large investors worry about control: they want to be able to veto management significant actions that they disagree with, including:

  • Any allotment or granting of rights to subscribe for shares other than as permitted under the Articles;
  • Any alterations to the provisions of the Articles;
  • Any reduction, subdivision, consolidation, redenomination, purchase or redemption by the Company of its own shares or other alteration in the share capital of the Company or any of the rights attaching to any share capital;
  • Any entry into a transaction where any director of the Company has an interest including without limitation the payment of fees or other remuneration or the alteration of the terms of service or remuneration of any director except where such fees or remuneration are in the ordinary course and are reasonable; and
  • Agree to the sale or disposal of any substantial part of the business, assets or undertaking of the Company including without limitation the licensing or disposal of any of its intellectual property.

It’s a balance: I need operational freedom to run the company, they want Board-level control of major decisions.  It comes down to trust: Neither doubts the other and promises not to interfere, but want their authority ‘just in case’.

In practice, we grant rights to major investors, subject to their continuing to have significant stake in the company and to putting their veto to a general vote of the minority shareholders if the Board determines that a veto is needlessly obstructive.

It’s all part of the Sisyphean task of securing and protecting resources, a universal issue that recurs throughout nature.  In that spirit,  I close with a video that I took of two Dung Beetles struggling with the task that all.

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