Raising capital? You can do it without giving up control
The valuation is only half the deal
How much is my company worth? What percentage does the investor get? And how much capital are they bringing in? These are often the first questions people ask when a private equity investor takes a seat at the table. But another question is at least as important: who decides after the investment?
An investor does not necessarily acquire economic rights alone. Representation on the board and arrangements around a future sale are frequently negotiated as well. Anyone who looks only at the valuation may therefore discover afterwards that, while they are still the majority shareholder economically, they can no longer take important decisions on their own. Good preparation therefore determines whether you remain fully at the helm afterwards, or whether you will have to share that role from now on.
In this article we briefly set out (i) how an investment comes about and (ii) which contractual rights and obligations are included in a shareholders’ agreement that may have an impact on the decision-making powers of the various bodies and individuals after the transaction.
How does an investment come about?
Legally, an investment consists of more than one contract. The process often runs in several stages:
- Term sheet
This largely non-binding document sets out the key terms of the deal, such as the percentage of shares, control rights and the arrangements around a later exit. - Due diligence
The investor reviews the business from a legal, financial and tax perspective in order to map out potential risks and points of attention. - Transaction documentation
The arrangements from the term sheet are worked out legally and anchored in the final agreements, including the shareholders’ agreement (see below). - Issue or transfer of shares
The investor acquires its stake by subscribing for new shares, taking over existing shares, or a combination of both. - Closing
Once all conditions have been fulfilled and the necessary documents signed, the transaction is officially completed.
The shareholders’ agreement: who gets to decide on what
Where several shareholders continue together, the shareholders’ agreement is the key document of the transaction. It determines what rights each party has. Typical arrangements generally cover:
- Governance
Which decisions can management take itself, and which require the investor’s approval? - Information rights
What financial and operational information does the investor receive? - New financing rounds
How is the investor protected against dilution (a smaller shareholding as a result of the issue of new shares), and can it invest pro rata alongside? - Transfer of shares
On what conditions may shareholders sell their shares? - Drag-along and tag-along
When can a shareholder sell alongside, or be required to sell alongside, for example on an exit? - Exit arrangements
How and when can the investor sell its stake again?
The costliest mistake is sometimes made before the investment
A term sheet, however few pages it may run to, often already determines a large part of the eventual deal. Signing it quickly so as not to slow down the negotiations is therefore not a good idea. Once the document has been signed, it is rarely revisited in any fundamental way in practice. That is why it is best to seek legal advice before the final contracts are on the table. Nor should the decision-making rights in a shareholders’ agreement be underestimated. Such an agreement can leave a director/majority shareholder powerless, ensuring that — notwithstanding holding the majority of voting rights on paper — that person in fact no longer has control.
Conversely, the agreement can of course also protect the investor against excessive decision-making power on the part of the shareholder/founder. In this way, the investment can be adequately protected.
Let Quorum guide you, so that the legal arrangements support your commercial ambitions.
So what should you watch out for?
…as an entrepreneur, you need to look beyond the investment amount and the percentage of shares you give away. Determine in advance which decisions you will still be able to take independently after the investment, which will require the investor’s approval, and what happens on a later exit. The term sheet deserves the same attention in this respect as the final agreements.
…as an investor, you need to ensure that essential rights are clearly and enforceably set out. Consider information and reporting rights, representation on the board, approval rights, protection in new financing rounds and clear exit arrangements. Also make sure the shareholders’ agreement and the articles of association are carefully aligned with each other.
So who holds the key after the investment?
A private equity investment is not merely a financial transaction. It is a shift in how your company is governed — and that applies to both parties. For entrepreneurs, negotiating well can make the difference between growth capital with entrepreneurial freedom and growth with limited room for manoeuvre. As an investor, your preparation helps determine how well your interests are protected, both when things are going very well and when they are going less well. Those who obtain legal guidance from the very first discussions avoid a promising partnership ending in a difficult power struggle.
Would you like to raise capital, or invest in a promising business yourself? Quorum Law guides entrepreneurs and investors from the first conversation to the final signature.
