Clauses Commonly requested by venture capital investors

Rainbow at sea with some cruising ships - C.W. Eckersberg

Venture capital investors almost always require the same type of clauses when they desire to invest in a startup. These clauses are included within the shareholders agreement to formalize between the founders, the venture capital investor and, often, other pre-existing partners such as business angels. However, some of the clauses are also included in the bylaws of the company.

(1) First clause to be highlighted is the establishment of reinforced majorities for the adoption of certain matters at the general meeting (majority reserved matters). This clause allows the venture capital to veto the subjects included as majority reserved matters.

(2) Second commonly regulated clause, is the commitment of one or more entrepreneurs/founders of the company to remain in the company a minimum period. With this kind of clause the investor can identify certain key employees of the company to ensure the business will continue as it was before its entry. This clause can prevent the founders both to transfer its shares in the company and to cease its employment or services relationship with the company. This clause use to exclude other partners not considered key employees, such as business angels and friends and fools.

(3) A third common clause to be highlighted herein is the liquidation preference. This clause established the right of the investor to receive certain amount of money before the rest of the partners, usually limited to the recovery of the amount invested by the venture capital. Therefore, in case of liquidation event, such as: dividends, transfer of assets, transfer of shares, winding up, etc. this investor will be reimbursed with preference over the rest of the partners.

(4) The fourth clause to be highlighted here is the drag along clause. By virtue of the drag along clause, the investor can force the rest of the partners to transfer its shares, stock or interests of the company together with him, in favour of a third party, provided that certain requirements are met and under the same terms and conditions.

Although these four clauses highlighted are the most defining of venture capital investments, there are others that are also important and common, such as the right of the investor to: (5) receive period information regarding the status of the company, (6) appoint a member of the board of directors, (7) non-competition and exclusivity of the founders/entrepreneurs, (8) anti-dilution, (9) no distribution of dividends, and regulation of the limitation on the (10) transfer of shares, stock or interests of the company, (11) administrative body operations, (12) tag along clause, (13) good and bad leaver, (14) implementation of incentive plans via stock options or phantom shares, (15) syndication of votes, referred to partners with less than determined percentage (commonly 5%), etc.