Investment agreements: key clauses to protect existing partners

Investment agreements: key clauses to protect existing partners

When a company seeks to attract investment, it is essential to establish agreements that regulate the relationship between new investors and existing partners. A well-structured investment agreement protects the interests of the founders and avoids future conflicts. Below, we explore some of the key clauses to consider in such agreements.

Permanence and non-compete clause

One of the most relevant aspects is the continuity of the founding team. To ensure this, a lock-up period can be included, which obliges the current partners to remain in the partnership for a certain period of time.

In addition, non-compete clauses applied to new partners prevent the partners from participating in similar businesses for a certain period of time after their departure from the company.

Partner entry and exit clauses

It is vital to regulate the entry and exit of partners to avoid the arrival of unwanted investors or the disorderly exit of existing ones. Some of the most commonly used clauses are:

• Right of first refusal: in the event of the sale of shares, the current shareholders, or the company, have priority to buy them before a third party.
• Drag along: allows a majority shareholder to force the minority shareholders to sell their shares if they receive an offer to buy a significant percentage of the company.
• Tag along: protects minority shareholders by allowing them to sell their shares on the same terms as the majority shareholders if the latter decide to sell. This clause aims to prevent minority partners from being trapped in a partnership with new partners they have not chosen.

Depending on whether the current partners after the entry of third parties are majority or minority partners, one or the other would be included in the investment agreement, and thus in the shareholders’ agreement.

Preference in case of sale, dissolution or liquidation

One of the main risks for existing shareholders is the dilution of their shareholding following the entry of new investors. To avoid this, anti-dilution clauses can be included to ensure that, in future investment rounds, existing partners will maintain their shareholding. There are different types of anti-dilution protection, including:

• Full ratchet: adjusts the price of existing partners’ shares to the lowest price of new issues, avoiding any dilution.
• Weighted average: allows a partial adjustment depending on the number of shares issued and their price, reducing the impact of dilution.

Remuneration clauses and preferential dividends

To prevent new investors from prioritising dividend distribution over sustainable growth of the company, clauses can be included to protect existing shareholders. Some measures include:

• Priority reinvestment: this provides that some or all of the profits must be reinvested in the company before dividends are paid out, ensuring the growth and stability of the business.
• Target dividends: dividends can be made conditional on the achievement of certain strategic milestones, ensuring that resources are not diverted to the detriment of the company’s operations.
• Limitation of preferential dividends: caps can be placed on the amount of dividends that investors can receive, preventing them from absorbing a disproportionate share of profits to the detriment of existing shareholders.

These clauses protect founding and existing shareholders from investors who seek immediate returns without considering the need for reinvestment in the growth of the company.

Control clause and voting rights

It is crucial that existing partners retain control over strategic decision-making. This can be achieved by including provisions such as:

• Enhanced majorities: require the affirmative vote of a significant percentage of existing shareholders for key decisions (such as capital increases, sale of the company or changes to the corporate purpose).
• Veto rights: these give certain partners the ability to block strategic decisions that could harm their position.

Investment agreements can be a powerful tool to raise capital without compromising the stability of the company or the position of existing partners. By including appropriate protection clauses, loss of control, excessive dilution and the entry of unwanted partners can be avoided. To ensure a balanced deal, it is essential to have the advice of legal and financial experts to ensure the best protection for existing partners.