Any venture capitalist or business angel who has agreed to back an entrepreneurial team will almost certainly require the team to enter into what is known as a Shareholders Agreement.
This document (together with a document called the Articles of Association of the company - on which a separate article will be posted shortly) regulates the affairs of the company and will give the investors their main contractual protections. It will, of course, only be relevant if a corporate structure is being used - but this is by far the most common method for structuring private equity/business angel investment.
The main features of a Shareholders Agreement are:
- A list of material things which cannot be done without the prior consent of the investors. These will normally range from fundamental matters such as issuing further shares or charging assets to more day to day matters such as capital expenditure and so on.
- A right to information. It is extremely important for the investors to closely monitor performance, particularly to give them an early warning if things are starting to go wrong. Accordingly, they will expect a contractual right to receive regular reports, management accounts, cashflow forecasts and so on, together with statutory accounts. The investor will also often seek the right to have its own director appointed to the board. He will expect board meetings to be held regularly and all material decisions to be made by the board.
- Warranties from the management team. This will be the subject of a separate article but, in general terms, these are a series of statements about the company which the investors would expect to be true and accurate. At a first stage capital raising, it is unlikely that these will be little more than a confirmation that the team stands behind its business plan, that the company is clean and that the team knows of nothing which has been withheld from the investors. However, at subsequent funding rounds, once the company has a track record, then the warranties will extend to general trading affairs of the company.
- Restrictions on transfers of shares. Again, this will be the subject of a separate article but the investors will be very keen to ensure that the management team which they are backing hangs on to their shares. In certain circumstances, managers will be permitted to transfer shares to family or to trusts.
- Restrictive covenants. These will make it clear that while the management are employed and for a period of time afterwards they cannot compete with the company or solicit customers or employees. One would expect these covenants to dovetail with restrictive covenants contained in employment agreements but the covenants in the shareholders agreement will be directly in favour of the investors. It is obviously critical from the perspective of management that they are comfortable with the covenants they are entering into.
There are, of course, a number of other detailed provisions in an average shareholder agreement. It is normally quite a sophisticated legal document and the advice to any entrepreneur would be to consult his or her solicitor before agreeing to sign one. Similarly, no business angel should invest a substantial amount in any company without protecting himself or herself with contractual rights in a shareholders agreement.
If you have any questions on this article, please contact David Day on telephone 020 7367 2948 or e-mail dcd@cms-cmck.com.
