By John Finnemore, Partner, Nabarro
Many angel or small institutional investors are seasoned investors who have seen a number of investment transactions. They therefore know what to ask for when negotiating the shareholder documentation and what the position commonly reached between the investors and the company, known as the “market” position, will be.
The below is a list of things you should try to avoid agreeing:
(1) Rights for one shareholder to prevent further issues of shares or, even worse, provisions that state that all shareholders must agree to the issue of shares.
This will make it very difficult to raise future equity rounds or issue shares to anybody at all. Instead propose that shareholders who have a certain percentage of the shares can approve the issue of shares. That might be the holders of 75% (rather than the statutory 50%) if investors would like comfort that shares will not be issued if only a simple majority agree.
(2) Lengthy information rights, requiring you to produce large monthly reports and metrics.
This will quickly become a source of time-consuming frustration for you. Agree a simple reporting standard, to include access to management accounts and perhaps a brief update, but do not agree to long form information packs.
(3) An entrenched right to be on the board.
This means the investor can be a director even if they hold only 1 share in the company. This is not good from a corporate governance perspective and may mean that future investors are unwilling to invest in a company with a very large board of directors. Agree with the investor a percentage shareholding below which they will lose their right to appoint a director. Typically that would allow them a 50% dilution before that occurred.
(4) Rights for the investor to block an exit.
Many early stage investment documents contain “drag” provisions which allow the majority to force the minority to sell their shares if a price acceptable to the majority has been offered. Do not agree that an investor can block this process. If the investor will not agree to simply being dragged, agree a minimum price for the value of the company which must be offered before the drag can be utilised.
(5) Right to stop any changes to the shareholders’ agreement or articles of association.
This right may well mean that you are not able to take further investment into the company as new rights or provisions related to shares will not be capable of being added into the documentation. Consider either agreeing that holders of a certain percentage of the shares can agree to this (perhaps 75% as above) or that the changes can be made if they do not materially and adversely affect one particular shareholder.
If you are in doubt as to anything above you should take legal advice.