SHAREHOLDERS’ AGREEMENTS

In every corporate restructuring and investment transaction, shareholders’ agreements are entered into, i.e. agreements between partners: on the one hand, partners already present within the company, such as founding partners or investors from a previous round, and on the other hand, new investors. The purpose of a shareholders’ agreements is to delineate a series of rules and clauses that establish the rights of everyone within the company and define the extent to which a partner may take certain actions.

Shareholders’ agreements are used within the context of capital raising in start-ups, at the moment in which the investors (whether they are funds, business angels or businesses) decide to invest in an entrepreneurial initiative and want to have certain rights to protect their investment. The founders of the company, in turn, impose limits on new investors, for security and to avoid excessive influence or speculations.

This article will examine this type of contract in detail, and the most common clauses which are inserted in the agreements. Before looking at the clauses, it is necessary to clarify that there are many possible clauses and it would be impossible to cover all of them here. Also, there are no ‘right’ or ‘wrong’ clauses, since each investment is different from another, so we will focus on the most useful and recurring clauses within the agreement. It is also important to remember that shareholders’ agreements are only one part of the investment contract, which includes many elements.

THE CLAUSES

BOARD OF DIRECTORS

This clause gives the investor the right, of an administrative nature, to appoint and revoke the members of the board of directors. In the case of a board composed of ten members, usually, six are appointed by the founders (and the managing director is chosen from among them), and the remaining four are appointed by investors. Usually, the investors choose the chairman, while they do not appoint the managing director.

RIGHT OF VETO

The investor may be granted a right of veto on certain resolutions, whether it is a resolution of the shareholders’ meeting or a resolution of the administrative body. Concerning shareholders’ resolutions, the possibility of vetoes is usually required for: amendments to the articles of association; extraordinary transactions such as mergers; the issue of new classes of shares; changes in rights; stock option plans; the purchase of treasury shares; and the distribution of dividends or reserves. As far as the administrative body is concerned, the right of veto is required with regard to the modification of the budget, the assumption or modification of loans beyond certain amounts, and the purchase or sale of company shareholdings or individual assets.

RIGHT OF FIRST REFUSAL

This clause establishes that, in case of sale of the shareholding, each shareholder is obliged to offer it to the other shareholders before selling it to third parties, under the same contractual conditions.

RIGHT OF SATISFACTION

The satisfaction clause states that each shareholder is obliged to request and obtain approval (an authorization) from the person invested with this power for the transfer of its participation to third parties.

LOCK-UP

The ‘lock-up’ clause, establishes a limitation on the free movement of shares. The clause prevents founders from transferring their shares without first obtaining the consent of the majority of investors for a predetermined number of years.

RIGHT OF DRAG-ALONG

The drag-along right is a clause to protect investors if a buyer willing to acquire a higher stake than that held by investors is identified. If the majority of investors choose to sell the share, then those investors have the right to force all investors to sell. In this way, it is possible to mitigate the possibility of some small investors opposing a sale desired by the majority.

RIGHT OF TAG-ALONG

The right of tag-along is a clause designed to protect investors. It establishes that if a founder decides to sell all or part of his share (for example 30% of his share) to a third party, investors also have the right to sell their share (for example 30% of their share) proportionally at the price determined by the valuation of the company. If the sale of the shares concerns 50% or more of the share capital, investors have the right to sell their shareholding in full. As stated above, the founder may not choose to sell during the Lock-Up period without the consent of the majority of investors.

LIQUIDATION PREFERENCE

This is a standard clause in Venture Capital investments to protect investors. The clause comes into force during distribution events, such as profit distribution or sale of shares, and may be either preferential or participative. Preference is in the form of a right in favour of the investor in the event of an exit. He may receive the full value of his share before other investors (without preference) receive any consideration. Participation is in the form of an additional right for the investor (again in the event of an exit) to receive not only the full value of his share but also a multiple “x” of the investment made, this time in competition with the other shareholders, in a percentage equal to his shareholding. It is possible to limit (cap) the return on the investment for preferential investors, setting a ceiling above which the participation lapses.

ANTI-DILUTION

In the event of a future capital increase with a lower valuation than that contained in the contract, the investors who sign the agreement have the right to buy, at nominal value, sufficient shares to increase their shareholding, so that it corresponds to the one they would have obtained if the valuation of the round had been equal to the new and lower valuation.

EARN OUT

The earn-out clause allows the transferee of shares in the company to tie the sale price to the company’s growth potential. It establishes an initial price, so-called ‘fixed’, which will have to be paid independently of the positive or negative performance of the company; and a variable price, so-called ‘earn-out’, which will vary according to the objectives actually achieved in a predetermined period of time. The closing price is therefore based on the achievement of criteria and results predetermined by a specific program (‘earn-out’ agreement), usually linked to the exceeding of a certain EBITDA, net profit or turnover. To simplify, the parties agree on a change in the sale price of the shares, based on the future growth or decrease of the company.

OPTIONS: CALL AND PUT

A put option guarantees one of the parties the right to disinvest through the sale of its shareholding to the counterparty, usually to the other or to another partner, when certain conditions are met. In this way, a possible exit to the economic transaction is created.

MANDATE TO SELL

Investor protection clause. It states that if after a predetermined number of years, if the company has not yet been sold, then the majority of investors have the right to appoint a business intermediary to sell the company.