ADAPTING ARTICLES OF ASSOCIATION FOR STARTUPS: FLEXIBILITY AND GROWTH CONSIDERATIONS

Introduction

 

The Articles of Association play a crucial role for any startup company. They set up how the day to day of a company runs and are managed by various administrators in the company.. These documents spell out the rules the company will follow and also explains the role of directors, how shares work, and what rights shareholders have. The AoA helps make things clear by preventing any dispute that may arise in future, and makes everyone feel more sure about the company. It determines the rights, liabilities of the shareholders and other aspects related to shares, their transfer, call on shares, dividends, capital alteration and so on. It specifies the manner of conducting meetings and requirements and process to be followed for meetings. It provides for the roles, responsibilities and extent of authority of the board of directors.. When written well, an AoA can let businesses change with the times while still following the law and doing what’s best for founders and investors. In short, the AOA sets up the legal base a startup needs to grow and expand its company.

 

Section 2(5) of Companies Act, 2013 defines AOA as “ Articles means articles of association of a company as originally framed or as altered from time to time or applied in pursuance of ant previous company law or of this act. 

 

Key Clauses To keep in mind while drafting Article of Association

 

1. Shares – this article mentions various provisions pertaining to shares, such as kind of share capital, process related to issuance, allotment, and transfer of shares.
2. There are various rights which can be mentioned in the article of association in order to prevent any dispute in future.

• Pre-emptive and anti-delusional rights given to certain shareholders, when they are offered certain additional shares each time, the company issues shares to a new investor so that the shareholding of such existing shareholder does not get diluted.
• call option which is mentioned upon the happening of a trigger event and gives the right to require the other party to sell its shares to the option holder
• Put option in the happening of a trigger event gives the right to other party to purchase it shares to the option holder
• Right of first refusal – this article mentions each time, a party intends to sell its shares and receives an offer from a third-party, It shall take the offer to the right holder. If the right holder is able to match the offer or give a better offer than the selling part shall sell its right to the right holder. In case the right holder refuses to purchase the shares of the selling party at the same or better offer than the said party and the selling party shall be free to sell its shares to the third party.
• Right of first offer – this article mentions that each time a party intends to sell its shares. It shall first offer the shares to the right holder.
• Tag along right – in case a shareholder selling its shares to a third-party, then the right holder, usually a minority shareholder shall have the right to tag along in the sale,
• Drag along right – this article mentions that in case a right holder, usually majority shareholder, is selling shares to a third-party. Then it will have the right to drag the other shareholders to send its shares to the third-party as well.
• Buyback shares. This article lays down the process of buyback shares as well as right of certain shareholders to require the company to buy back the shares,
• Employees stock options – this article mentions the number of options in the ESOP pool of the company, power of the board to issue ESOP to the eligible employees, etc.

1. Board of directors and their meetings – this article talks about the number and kind of directors on the board, the quorum requirement of the board meetings, the process of conducting board meetings, adjournment, require of shorter consent, nominee director rights.
2. Shareholder meetings: this article mentions the quorum requirements for shareholder meetings, adjournment, process of conducting meetings, requirement for shorter consents.
3. Dividends: this article mentions about the dividends of the company and how this is to be distributed by the board.
4. Indemnity – this clause provides for indemnity for all directors by the company for any costs incurred by them in the bona fide discharge of the duties for the company

 

Successful Adaptation of Articles of Association : Real-world example of a startup that successfully adapted its articles of association for growth.

Case Study 1: Facebook

 

Compared to other companies of social media, Facebook, which was a small startup at the beginning of the company, also revised its articles of association to fit the growing pace of the company’s development and diverse business requirements. First, Facebook started as a company in 2004 and in those early submitted articles, focus was put on founders’ control to retain vision and when the company grew and was planning for the IPO in 2012, many changes occurred. These were staying with a dual class of share Kamp, structural coupling to tailor the founders’ control while sourcing for the capital. This structure proved useful in that it allowed Facebook to obtain the needed capital to grow, but without giving up substantial control to outside investors, which exemplifies Facebook’s ability to alter the articles in its favour to achieve both growth and consolidation of power.

 

Case Study 2: Spotify

 

Another firm that changed operating articles of association for its growth was the music streaming giant called Spotify. In the early stages of its development, Spotify in its articles focused on the company’s positioning in the sphere of music. With this development, the company had to solve the problem of attracting international shareholders and operating licensing agreements with record companies. Translations made to Spotify’s articles were corrected for new concepts like the use of classes of shares for ownership of different risk taking and decision making ability by shareholders. This flexibility in their articles was a plus for Spotify to meet or respond to the ever-growing market forces, especially while expanding its operations.

 

Case study 3: Zoom

 

Zoom is an online meeting app that started in 2011 and especially benefited from the COVID-19 crisis. Earlier, the members of Zoom have set their articles of association to fit into the conventional format of startup companies. However, as the company grew rapidly, it was realised that there was a need to change its governance structure to fit the new company compounded with the need to conform to some of the regulatory measures. Amendments were such aspects as terms for board of directors’ diversity and its independence as well as definitions of work of executive and non-executive directors’ responsibilities. These adjustments assisted Zoom to overcome the problems associated with the fast growth, keep on preserving the principles of corporate governance, and carry on introducing new exclusive solutions within the sphere of high competition.

 

Adapting to Growth: Modifying articles of association to accommodate growth stages and expansion.

Pursuing growth and expansion of the startups change the business landscape and, therefore, their Articles of Association (AoA) may require amendments to reflect changes in the company’s structure, strategy and goals.

 

1. Increasing Share Capital

 

Perhaps one of the major changes that may be made in the AoA may relate to provisions for a business to increase share capital. Equity investment is another major source of funds which a company applies as it grows up. The AoA should also provide provisions for the issue of new shares Since flexibility is required in stock management, it is critical to attract investors and retain talents.

 

2. Changing of the Number of Votes Needed and the Classes of Stock

 

Startups are usually founded with a basic share structure, but it becomes possible to give various classes of shares with various rights and privileges with growth. For instance, the issue of preference shares can guard the early investors’ interest through providing priorities to the investors. It is thus vital for the AoA to outline these rights like voting rights, right to dividends, and right to preference in stock take-over with clarity to avoid legal brawls.

 

3. Updating Corporate Governance Policies

 

We also know that growth introduces other themes in the governance of these firms, and these include handling of conflicts of interest, improvements in the compliance mechanisms as well as handling of accountability issues. The AoA’s should be adjusted to have sound governance structures that enable adherence to best practice and regulations.

 

4. Facilitating International Expansion

 

In case where a startup has a strategy to go global, the AoA may require some changes to reflect the laws of a new country or region. This also covers provisions of laws on establishment of subsidiaries or branch offices or other forms of associates or affiliation in other countries.

 

Therefore, it is crucial to amend the Articles of Association when the startup is in the process of its development as it is necessary to have an effective and adaptive legal framework for the company’s functioning. Such changes facilitate the introduction of new rules in the legal regulation of companies and their business, contributing to the formation of an adequate model of relations to attract investments, minimise threats, and create new opportunities. In this respect it can be suggested that more frequent and timely revisions to the AoA can help to protect the company’s interests and support its development.

 

Authored by- Areen Asif, Jindal Law School at OP Jindal Global University

 

References

 

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