What do investors look for in a shareholder agreement?

Why do negotiations between and investor and founder shareholders typically break down? What are the deal-breakers?

Typically, economics are not the reason that investors step away from negotiations to take a stake in a company. It is more often about the control terms in the shareholder agreement.

Will an investor want a right of veto over key decisions?

An investor will want to make sure that their money is put to good use and, hence, often focus on including a list of key decisions with rights for the investor to block certain decisions – for example, if the founders try to increase their salaries without asking for investor consent or if the founders try to change the nature of the business. It is a red flag for an investor if the founders refuse to agree on some key restricted decision rights, despite the investors holding only a minority in the company.

What are drag-along rights and why are they important?

Drag along rights permit that there can not be a sale of the company unless all of the shareholder, including the minority shareholder are included in the sale. For example, the buyer must make an offer to all shareholders, not just the majority shareholders. This term can force both investors and founders to agree to a deal.

What are the typical red-flags for investors?

Strong control rights for a shareholder: it is a red flag if a shareholder (especially an operationally not active shareholder) has too much power. When negotiating the SHA, it usually helps to discuss the concrete scenarios that the respective parties (both founders and investors) are worried about, which typically makes it easy to find common ground on a specific term.

Is it worth getting a lawyer involved in the negotiations?

The good lawyers will help you find solutions that accommodate the concerns of all parties, whereas the bad lawyers will try to cover their clients’ needs at all costs. Having a good lawyer will also help to avoid that anybody steps away from the deal.

What are the elements that an investor will not accept in a shareholder agreement?

If the founders wish to be able to change the nature of the company’s business without the consent of the investor, or issue new shares or an exit.

Does an investor need to be a director as well?

Founders are often worried they will lose control by agreeing to appoint too many new directors. Investors are usually also keen to keep the board as small as possible to enable the company to make decisions quickly. However, with every financing round, the investor base will grow and many of them have a requirement to be represented on the board.