Associates Pact: What clauses are the most problematic when selling a startup?

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Pacts from partners, agreements between startups and investors, determine the rights, obligations and protections of the parties for an investment. Understanding their clauses, and entering the financial and strategic implications, is crucial to negotiating an ad hoc shareholder pact.

To talk about it, we interviewed Romain CottardManaging partner ofAder Financespecialist in fundraising and M&A, as well asOlivier Sanvitilawyer and manager of the ACT Legal cabinet

What clauses are the most problematic when selling a startup?

For Romain Cottardthere preferential liquidation clause is often a major point of friction:

First, the preferential liquidation clause, which gives the right to financial investors to recover their money as a priority during the sale of a start-up; This almost systematic clause can be a real brake on a sale when the price offered by buyers is not as high as anticipated, which can cause a situation where a very large part (or even all) of the sale price goes in the pocket of financial investors. »»

Olivier Sanviti underlines the complexity of these clauses and the importance of suitable legal support:

There are dozens of types of preferential liquidation clause, the traps can be many and each detail, each word counts. My advice is simple: be well accompanied by a lawyer who is used to this type of clause and knowing market standards. »»

Another clause that can be problematic: the Joint outing obligation clause (Drag Along)which allows you to force a sale if a certain percentage of shareholders (generally 70-80%) accepts a buy-back offer.

It can sometimes be problematic when the threshold necessary to trigger the sale is not reached. »»

Finally, the Forced liquidation clausewhich allows investors to impose the sale of a startup after five years without the agreement of the founders, is often perceived as a threat. Yet, Romain Cottard nuance this received idea:

Contrary to popular belief, the forced liquidation clause, allowing financial investors who entered the capital of a start-up 5 years ago to sell it even without the agreement of the founders is only very rarely problematic: it is almost impossible to sell a still young start-up (and therefore often dependent on its founders) without the full cooperation of its founders (while it is much more common for more mature companies of the private equity type). »»


What clauses infect the attractiveness of a startup during the following financing towers?

According to Romain Cottardsome clauses are reassuring for investors, while others can be a brake:

The Good/Bad Leavers clauses (promise of disposal of shares in the event of departure) which apply to the founders of start-ups are very reassuring for investors, because they make it possible to ensure the operational presence of the founders during the duration of the investment; They are almost always requested during a fundraising. »»

“The inalienability clauses of titles, preventing shareholders (often founding) from selling their titles for a certain period without the agreement of investors are also likely to reassure investors, by guaranteeing that no one” leaves the ship ” along the way, and that the interests of each are therefore aligned. »»

However, some clauses may complicate subsequent levees. This is particularly the case with Ratchet clauseswhich adjust the participation of historical investors if a later turn is made of a valuation below the previous one:

Finally, adjustment or “ratchet” clauses can complicate subsequent financing towers: this clause allows historic investors to reread themselves in capital if the subsequent financing tour is made to lower valuation than the previous round; We have seen these clauses a lot apply in 2023 and 2024 due to the drop in valuations vs. 2020 and 2021; When applied, the impact on the distribution of capital is sometimes violent and can complicate a later turn in which the founders would be too diluted. »»

How do the Term Sheets clauses differ between the early-starting startups and those in the scaling phase?

If the majority of clauses remain similar, some evolve as the startup is gaining maturity.

Romain Cottard identifies several major differences:

A large majority of legal clauses are similar between Early-Stage start-ups and those in the scaling phase. However, there are some differences/developments:

First of all, financial thresholds: where founders of start-ups often have to request the agreement of their investors to recruit an unpretentious profile with a salary over 100k € annual gross, or take out a loan greater than 100K € , these thresholds are generally higher for more mature companies, and managers have “freer” hands in their operational management. »»

Then, the clauses governing governance (who directs the company?) Evolve: where founders of Early-Stage start-ups cannot often be dismissed (because they hold a large majority of capital and that survival and Success of the company depend on them), start-ups in the scaling phase generally have a shareholder pact which allows shareholders to revoke the leaders if necessary (it is rare, but it happens). »»

Finally, the clauses of Good/Bad Leavers and inalienability of the titles are also more flexible: as a company grows, it is less and less dependent on its founders, and the mechanisms seeking to “lock” These founders operationally or capitalistically are less hard. »»

For Olivier Sanvitithe most sensitive clauses concern the governance and the departure of the founders:

If the question of valuation is resolved (as well as the possible ventilation between the actions and the obligations to be created) … relate to governance (places in the board, possible vetos, list of important and strategic decisions), and linked to the departure Founders (Good, Medium and Bad Leaver). »»

He also insists on an often neglected point: the insurance aspects of a deal:

The insurance aspects of a deal are sometimes neglected. It is super important to have RCMS insurance (civil liability of corporate agents – very useful especially if the company is liquidated judicially, etc.) and a GSC (Social guarantee of business managers and managers – Private unemployment insurance when the manager is dismissed from his corporate mandate …). »»

Small lexicon of associate pact clauses to know well:

Economic clauses: a financial priority

Liquidation preference

The liquidation preference guarantees investors a priority return in the event of liquidation, sale or merger of the company. She may include:

  • Non-participative (1x) : The investor recovers his initial investment before any profits sharing.
  • Participative (1x + profits) : The investor recovers his capital, then participates in the sharing of the remaining profits.

Example : A startup is sold for € 10 million. An investor having injected € 5 million with a non-participative 1x preference recovers its € 5 million, and the remaining € 5 million are distributed among the other shareholders. With a participatory clause, he recovers his € 5 million more a proportional part of the remaining profits.

Impact Entrepreneurs Investors
Benefits Attractiveness for investors Securing return on investment
Disadvantages Reduction of founders’ gains Less interesting for high valuations

The anti-dilution clause

It protects investors against dilution in the event of a later lifting to lower valuation. Two mechanisms are common:

  • Full Ratchet: Completely adjusts initial valuation to the price of the new lifting.
  • Weighted Average: Partially adjusts according to an weighted average between old and new prices.

Example : An investor holds 10 % of a company valued at € 10 million. If a lifting is made at € 5 million, the Full Ratchet allows it to increase its share to keep the same unit valuation as during the initial investment.

Impact Entrepreneurs Investors
Benefits Facilitates funding Protects the economic value of actions
Disadvantages Strong dilution of the founders Can slow future towers

Milestones Clause (investment slices)

The funds are released into several tranches, conditioned on the achievement of previously defined objectives, as the launch of a product or the achievement of turnover.

Example : An investor hires € 5 million, with a first bran of € 2 million immediately unlocked, and the remaining € 3 million conditioned for the acquisition of 10,000 users.

Impact Entrepreneurs Investors
Benefits Encourages performance Reduces the risk of exposure
Disadvantages Pressure to quickly achieve objectives Increased operational complexity

Control clauses: balance influence and autonomy

Representation on the board of directors

This clause allows investors to obtain a seat or an observer role in the Council, providing them with direct supervision on strategic decisions.

Example : A fund holding 25 % of the capital requires a seat to influence strategic decisions, in particular fundraising and acquisitions.

Impact Entrepreneurs Investors
Benefits Provides external expertise Direct supervision on strategic management
Disadvantages Reduces decision -making autonomy Can increase governance processes

Right of first refusal (ROFR)

Investors can prioritize actions put on sale by other shareholders.

Example : An employee wishes to sell his shares. Existing investors can exercise their ROFR to maintain control of the shareholding structure.

Impact Entrepreneurs Investors
Benefits Protects against the entry of unwanted shareholders Maintains the influence on the shareholding structure
Disadvantages Limits the flexibility of the founders Can increase secondary negotiations

Drag-Along and Tag-Along Clauses

  • Drag-Along: Allows majority investors to force minorities to sell their shares during a sale.
  • Tag-Along: Gives minorities the right to participate in a sale initiated by the majority.
Impact Entrepreneurs Investors
Benefits Simplifies output processes Protects the rights of minority
Disadvantages Can force the founders to sell Complete large transactions

Specific and rare clauses

Sustainability Clause (ESG clause)

Investors impose ESG (Environment, Social, Governance) commitments on the company, such as the achievement of certain parity or carbon footprint thresholds.

Example : A startup is committed to reaching carbon neutrality within 3 years to comply with a requirement for an investment fund dedicated to green technologies.

REDEPTION RIGHTS CLUSE

Allows investors to force the repurchase of their shares after a given period if no outing (IPO, acquisition) has occurred.

Example : After 7 years without liquidity event, a fund can request the reimbursement of its initial participation.

Impact Entrepreneurs Investors
Benefits Offers temporal flexibility Guarantees an outing even without IPO
Disadvantages Creates long -term financial pressure Can discourage future towers