Key clauses that you must include in your startup’s shareholder agreement

shareholders agreementStartups
César González – Co-founder and COO at The Startup CFO

My name is César González, co-founder and COO at The Startup CFO. As in past weeks my colleague Jaime Medina did, I leave you an opinion article in which we will talk about key clauses in startup’s shareholder agreements.

As its name suggests, a shareholder agreement is a private document that is drawn up and signed by the partners or shareholders of a startup that reflects the key aspects of its operation and the relationship between the partners and investors as a result of said situations.

In a shareholder’s agreement, the protocols to be followed by all parties in potential future situations are included, thus anticipating possible conflicts between partners and investors as a result of said situations.

Although this agreement is usually made when the company is constituted, it is recommended that it be updated in each new financing round with the entry of new investors, since the objectives of the startup and the profile of the investors may vary with the passage of time.

As part of this pact, we must include some key clauses to protect partners and investors against such possible conflicts and thus avoid divestments or abandonment of the founding partners, which would cause great damage to our startup.

From The Startup CFO we have written this article to talk to you about the clauses that you should take into account when preparing your shareholder’s agreement.

Three key clauses that you must include in your startup’s shareholder agreement

Drag Along

The drag along clause is added in order to protect investors who own it against a possible sale of the company in the event of receiving an offer to purchase.

This clause regulates the possibility that if the startup receives a purchase offer for the entire share capital, the partner with drag along can oblige the rest of the partners to sell their shares to the potential buyer.

This clause usually includes the minimum price for which the partners are obliged to sell in the event of a potential buyer (lower valuation limit), the option of the rest of the partners to match the offer and under what conditions, and the period of the exercise of the right of the penalty clauses in case of non-compliance.

To give a practical example, in case of receiving an offer, the investor can exercise the drag along as long as the total price offered by the potential buyer equals or exceeds the minimum price contemplated under this clause.

Tag Along

In contrast to the above, the tag along clause is added in order to protect the minority shareholders in the event that the majority shareholder receives the possibility of selling all or part of their shares and the former do not receive an offer for theirs.

This clause allows minority shareholders to sell their share of the capital stock to the potential buyer for the same price and under the same conditions as the offer made to the majority shareholder.

By including a tag along clause in the agreement, the minority partners ensure that the majority partner who has received the offer is not entitled to transfer the shares offered to the potential buyer without the latter extending its offer to the rest of the partners.

Proper wording of the drag along and tag along clauses is essential to protect the interests of both entrepreneurs and investors in the event of a startup exit.

Liquidation Preference

The liquidation preference clause allows venture capital investors to protect the value of their investment against other partners, especially in low-return scenarios.

In the event of liquidity or exit of the startup, investors have a preferential right to collect before the rest of the non-preferred partners, thus ensuring that they recover their investment or a multiple of it.

If you want to know more, we invite you to read the article that we prepared a few weeks ago.

Other important clauses

Anti-dilution clause

The anti-dilution clause allows investment partners to protect themselves against a capital increase in which the startup’s valuation is lower than what it had when they became part of it.

With the inclusion of this clause, if the startup carries out a capital increase with a value per share lower than that of said investor’s share, the investor has the right to have new shares issued to compensate for the loss in value or to have the capital restructured of the startup so as not to lose participation quota.

Pay-To-Play

The inclusion of this clause in a shareholders’ agreement obliges investors to attend the next financing round in order not to lose their preferential settlement.

Its objective is for the investor to commit to continue making financial contributions in successive rounds to ensure the necessary fundraising for the growth of the startup.

As its name indicates (“pay-to-play”), some kind of sanction must be established for the investor in case of non-compliance with the clause.

In Spain, the use of this clause is unusual and instead of it, liquidation preference or anti-dilution clauses are usually included in specific cases.

Two other key clauses that are usually taken into account in shareholder agreements are the confidentiality clause or the permanence, exclusivity and non-competition clause.

Do you need help to draft the key clauses of your shareholder agreement?

Now that we have explained the importance of having a shareholder agreement and what are the clauses that you must include in it, you may have realized that you need legal help.

At The Startup CFO, together with the company’s lawyers, we are specialists in advising startups in the face of this type of problem that, due to lack of knowledge, have doubts when drafting the key clauses of their shareholder agreement.

Think that a badly written clause can be a big setback for some of your partners and put the future of your startup at risk.

So if you are interested in receiving advice on how we can help you, we invite you to contact us at info@tscfo.com.

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