Shareholders’ agreements can be daunting, filled with legal jargon that can be confusing for founders. However, understanding the key terms is crucial for navigating transactions and protecting your interests.
I. Valuation of Shares & Dilution of Ownership
Convertible Securities: These are financial instruments, like convertible debentures or preference shares, that can convert into equity shares. They offer a blend of fixed income and the potential for equity participation. The conversion is typically at the holder’s discretion, triggered by specific events or milestones in the company’s performance.
Fully Diluted Basis: This term refers to a scenario where all convertible securities (like bonds and stock options) are exercised and converted into equity, showing the total number of shares outstanding. It’s crucial for understanding the potential dilution of ownership.
Anti-Dilution Protection: This is a key safeguard for investors, ensuring their investment’s value remains intact even if new shares are issued at a lower price. There are two main types: full ratchet (adjusts conversion price to match the new low price) and weighted average (adjusts based on an average of prices, providing a balanced approach).
Pre-Emptive Rights and Super Pro-Rata Rights: Pre-emptive rights allow investors to maintain their ownership percentage by buying new shares before they’re offered to others. Super Pro-Rata Rights go further, letting investors increase their stake in subsequent funding rounds.
II. Clauses Impacting Decision-making
Information and Inspection Rights: Investors often require access to specific financial and operational information, ensuring they are well-informed about the company’s performance. Inspection rights allow for on-site visits and thorough reviews of the company’s records.
Investor Directors & Observers: Investors may nominate directors to the board to represent their interests. These directors have fiduciary duties to act in the best interest of the company, not just the investor. Observers, on the other hand, can attend board meetings without voting rights or fiduciary obligations.
Non-Executive Status and Indemnification of Investor Directors: Non-executive directors aren’t involved in daily management and are typically indemnified against personal liability arising from their role.
Affirmative Voting Matters / Investor Approval Matters: Certain key decisions, like amending charter documents or restructuring, require investor approval, ensuring that major changes align with shareholder interests.
III. Share Selling and Transfer Provisions
Deed of Adherence: When new shareholders join, they must sign this document to agree to the existing shareholders’ agreement, ensuring consistency across the board.
Founder Lock-In and Vesting: Lock-in periods prevent founders from selling their shares too soon, ensuring their commitment to the company. Vesting schedules gradually unlock shares over time, incentivizing long-term contributions.
ROFO and ROFR: The Right of First Offer (ROFO) and Right of First Refusal (ROFR) give investors the chance to buy shares before they’re sold to outsiders, with ROFR being more restrictive.
Tag-Along Rights: These rights allow minority shareholders to join a sale initiated by majority shareholders, ensuring they can exit the company on the same terms.
IV. Exit Clauses
Exit Strategies: Exit provisions outline how investors can realize their investments, whether through IPOs, mergers, or third-party sales. An accelerated exit can be triggered by specific events, allowing for a quicker exit.
Drag-Along Rights: These rights enable majority shareholders to compel minority shareholders to sell their shares, facilitating a complete company sale.
Liquidation Preference: This clause determines the order and amount paid to shareholders in case of liquidation, ensuring preferred shareholders get their investment back first.
V. Miscellaneous Clauses
ABAC Compliance: Anti-Bribery and Anti-Corruption (ABAC) compliance is crucial, especially for companies with foreign investors, ensuring adherence to global anti-corruption laws.
Options and Clawback Provisions: Call and put options allow shareholders to buy or sell shares under specific conditions. Clawback provisions ensure that founders or employees return shares if they fail to meet performance milestones or leave prematurely.
Understanding these terms is key for founders navigating the complex landscape of shareholder agreements. They ensure that founders and investors alike are protected and that the company’s interests are aligned with long-term growth and success. For specific transactions, always seek professional legal counsel.
DISCLAIMER
The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.
