Last year, Hong Kong implemented the Company Ordinance, which modernised legislation to highlight the protection of minority shareholders. An issue that’s just as important to entrepreneurs as it is to corporates, sustainable shareholding delves into a legal web that’s unique to each country — although tenets of a solid structure remain the same. The issue of shareholding is highly complex - one that requires the experienced eye of a professional. But we’ve collected some general notes for aspiring startup leaders to consider!
After a company is formed, the team joins in layers: (1) the founder(s), (2) employees hired within the first year, (3) employees added in the subsequent year, which repeats until typically the 5th layer (of which the company should be at a sustainably large size). At every step along the way, the risk for the employee decreases as the company grows, as it eventually makes a profit. Typically speaking, the founders will assume 50% of the shares, with the first 5 layers of employees assuming 10% of the shares, where employees from each layer will assume an equal number of shares (Source). This process is made more complex if a founder is a financier, if not all founders need a salary, or if a founder cannot work full time. All these discrepancies directly affect shareholding from the onset, and should be discussed early on.
A vesting schedule is crucial to protect the company, ensuring that the shareholder earns their shares. While this practice is normalised, studies have shown that the mistake of leaving this out of the shareholding structure is more common than we may expect. When it does occur, it can be devastating for the company.
No startup company wants to think about liquidation when they first start about their business, but it’s important to set up through and structured financial agreements so that all parties are adequately protected. Many times, entrepreneurs are going into a business without any financial background. Even so, they should be acquainted with different types of liquidation preferences and exit values that best suits the company.
Talk of Hong Kong becoming Asia’s Silicon Valley is not fully unfounded, as an average of 700 new companies is being formed daily in the city (Source). Creating a sustainable shareholding structure not only requires an understanding of public policy or related litigation. Understanding corporate culture and the local constituency relative to shareholders is also a significant aspect of building a sustainable structure. Only in the past couple of years has Hong Kong’s business world stressed the importance of shareholder protection, so this domain can be considered as somewhat immature. The city holds a longstanding regard for the idea of ‘buyer beware’ (Source), meaning that the government has remained hands-off in regulating the issue, believing that investors don’t require handholding. But new legislation has signalled a paradigm-shift. The new ordinance has streamlined modes of communication, financial reporting, and business reviews to benefit the shareholder, so a more transparent and efficient regime can come into play.
There exists a vast amount of literature on equity sharing models, so instead of spending the next couple of weeks pouring over dry legal textbooks and contradicting blog posts, why not join us for our next Garage Academy event Sustainable Shareholding Structures for Startups? This 2-Part workshop is led by Cermaine Cheung, a Partner at local law firm Choy, Cheung, and Co (in association with Han Kun Law Offices), and will go through common issues in shareholding structures of SMEs, dos and don’ts, and more!
Part 1: Tuesday, 14 July 2015, http://bit.ly/SharesGS
Part 2: Tuesday, 21 July 2015, 7:00 pm — 9:00 pm
Garage Society, 19F 299 Queen’s Road Central, Sheung Wan
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