"Startups, be sure to write a shareholder agreement!"

On the 13th, a seminar titled “Startup, How to do it with unfamiliar investment contracts?” was held at the Startup Alliance in Seolleung Station, hosted by Platum, with Yang Kyung-jun, CEO of ‘K Partners & Global,’ and Choi Sung-ho, a lawyer from law firm ‘Zen,’ as keynote speakers. Choi Sung-ho, the second speaker of the day, is a lawyer who serves as counsel for Partygames, Programms, Hyper Connect, and Dunamu, and is an attorney who is evaluated as conducting business from the perspective of a startup.

Here's a summary of Choi Sung-ho’s lecture that day. Business entities have higher external creditworthiness compared to individual businesses, making it easier to raise funds. There are many possibilities, such as receiving investment or having funds coming in through the infrastructure of shareholders. In terms of taxes, individual businesses are subject to a 6%-38% 5-step progressive tax rate, while corporations are subject to a 10%-22% 3-step progressive tax rate. This means that individuals must pay up to 38% of taxes on their taxable income (net profit), while corporations pay up to 22%. That is, corporations pay less tax. Also, all issues arising in management, debt, and loss must be borne entirely by the individual business owner, while corporations have shareholders, so there is an effect of dispersing responsibility. However, establishing a corporation is more complicated than running an individual business, and even if profits are generated, they cannot be used arbitrarily. Profits must be taken out only as shareholder dividends or salaries. Moreover, there are many things to worry about. Choi Sung-ho talked about what to look for when establishing a corporation and the need for a shareholder agreement. “First of all, when establishing a corporation, the most important thing is how much capital to have and what the par value will be. In particular, excessive par value should be avoided. I usually recommend between 100 and 500 won. This often makes things more convenient. For example, one of my clients had a par value of 10,000 won. The company has developed to the point where the share value is currently 3-4 million won per share. Therefore, it is difficult to give 10 or more shares when issuing stock options. That is, it does not help with stock distribution. Secondly, there is a time when shareholders need to negotiate after the corporation is established.

“With extreme examples, let’s say there are shareholders A, B, and C. If A and B fight, and B leaves but wants to keep their shares without disposing of them, there is no shareholder agreement, so B can have a share of the company's equity without doing anything. This is a cause of a sharp drop in the value of the company when a third party, including investors, looks at the equity structure of the company. Many investors are important about what roles the major shareholders are playing. This is why a shareholder agreement is needed to prevent such situations beforehand.” The shareholder agreement that Choi attorney mentioned is a document that specifies the contents of the agreement between shareholders who have shareholder rights. Attorneys recommend it to companies and startups with multiple founders, but it is not generally followed. There are many cases where this is due to a desire to avoid emotionally charged events from the beginning. The problem arises when the company is about to reach a turning point, such as investment.

Investors and external evaluators look closely at what roles the company’s major executives and shareholders are playing and whether their equity is divided according to their responsibilities. As Choi attorney said, if one of the major shareholders is doing nothing and just holding equity, it will be difficult for the company to receive a good rating. Therefore, the shareholder agreement should contain information about equity distribution based on responsibilities and information about responsibility. Choi attorney emphasized several points regarding shareholder agreements. “Shareholder agreements are about shareholders fighting with certain rules when disputes arise between shareholders. If there is no such agreement, there is a high risk of a ‘free-for-all.’ First of all, a ‘period of obligatory service’ of 3 or 5 years should be stipulated in shareholder agreements. If this provision is missing, it can lead to a situation where rights are claimed without obligations. Secondly, a penalty should be specified for failing to complete the period of obligatory service. For example, it could contain language such as ‘all shares held must be returned if the period specified in the contract is not met’ or ‘share ownership is recognized only for the period worked.’ Such rules are very difficult to adjust after the company has grown. It's best to create them at the start of the company. I’m aware of several companies that have struggled due to the lack of this language. Also, it would be good to include confidentiality clauses for shareholders and clauses specifying a court jurisdiction for disputes that arise.

Shareholder agreements have many standardized parts. But there are also unique cases. Investors pay attention to the shareholders’ equity when investing. In particular, how much the CEO holds is a major issue. If the CEO holds a small amount of equity, the rating may be lower. However, it’s not easy for companies with multiple co-founders. Therefore, a unique shareholder agreement has recently appeared. In short, it appears externally that the CEO holds a large amount of equity, but in reality, it is divided equally. This content has the potential for problems. When investing, VCs have a clause called 'truth and guarantee.' This requires a full disclosure of the company's equity structure and a guarantee that it is factual. If there is a difference between the externally expressed and actual equity, the VC may address it later. It may seem reasonable to divide shares equally, but investors’ thinking may be different.

Finally, Choi attorney concluded his lecture with advice on investment contracts. “Startup CEOs are embarrassed when they receive investment contracts. They don’t fully understand the content, and many of the provisions seem unfair. However, investment contracts are not really that difficult. Contracts define rights and obligations. That is, investment contracts formalize the rights and obligations of startups and investors. Approaching it from that perspective will make it a bit easier to understand. Startup CEOs are worried about being too interfered with. For example, rights of consent and rights of consultation should be clearly defined to prevent excessive interference. The right of consent is usually necessary for matters such as amendment of the articles of incorporation and issuance of new shares, which allows the company to be rationally changed based on it. However, if a VC holding less than 10% of the equity has the right to nominate board members and the right to consent to board members, problems may arise. The right of consent is, again, akin to a right of veto. This means that if a new person is recruited, the investor may veto it, making it impossible to work together. Also, if internal board or shareholder meetings require consent, it may be inconvenient. Those clauses related to the right of consent should be deleted as much as possible and the contract should be stamped. When the relationship between investors and the company is good, there is no need to look at the contract. But when the relationship sours or the company has problems, the contract becomes a backlash. If something isn't done properly when the contract is concluded, it can cause problems down the road.

Law firm ‘Zen’ and Yang Kyung-jun, CEO of ‘K Partners & Global,’ were unable to be reached for comment.