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The privileges of venture capital

| News | Corporate Law and Commercial Contracts

Venture capital investors and their privileges during investment and disinvestment

It is common for venture capital investors, attending to their activity, in addition to requiring a strengthening of their political and economic rights during their investment, also try to keep this investment safe and ensure their exit when their divestment takes place. For this, it is frequent for them to demand, in addition to the well-known tag-along and drag-along agreements, the inclusion of measures that protect their holding in the share capital and to try to ensure recovery of their investment, or even a return on the same, even in the event of certain circumstances that may be unfavourable for other partners.

In order to implement the above, the venture capital investor demands to become a privileged partner and, as the holder of privileged shares/holdings:

1. In the case of capital increases, holding an anti-dilution right, which grants the investor the right to subscribe/assume new privileged shares/holdings, if as a result of the new capital increase, the shares to be issued or the capital to be created, were of a value below the weighted average price paid by the privileged shareholder for the privileged shares/holding, upon investing in the company.  A form of instrumenting the foregoing is the issuance/creation of privileged shares charged to the company’s free reserves or, if these do not exist or are insufficient, by subscribing/assuming these at their nominal value, without an issuance/assumption premium, in the amount required in order for the privileged partner to endure a dilution in value of the holding. Logically, only a privileged partner will have the right to subscribe/assume new privileged shares which are issued or created, hence other partners who are not holders of privileged shares, would have to waive the right to preferential subscription/assumption to which they are legally entitled.

2. With the aim of ensuring that the investor recovers the investment made (and sometimes also the minimum return agreed), the remaining partners would recognise the investor’s right to a preferential liquidation privilege, which applies in the following cases:

  • In the event of dissolution and liquidation of the company (voluntary or forced). In the end and after having carried out the legally foreseen liquidation proceedings, the privileged partner would be entitled to receive from the company, in a preferential and privileged manner, a liquidation fee equal to the amount paid for purchasing the privileged shares (plus the interest agreed in each case). After having made said payment to the privileged partner, the resulting company assets would be distributed among all partners, in proportion to their respective holding in the company’s share capital at the time of the liquidation.
  • In the event of a sale of the shares representing 100% of the share capital, or when any transaction is carried out by virtue of which the privileged partner transfers all his/her privileged shares, said privileged partner would be entitled to receive from the acquiring third party in concept of price (if this reaches such an amount), a sum equivalent to the amount paid for purchasing the privileged shares (plus the interest agreed in each case). After said payment, the amount remaining of the price would be distributed among all other partners, in proportion to their respective holding in the company’s share capital at the time of the sale.
  • In the event of sale, lease, unlimited exclusive license or another disposition of all or substantially all the company’s assets, the partners would be subject to the commitment to hold an extraordinary General Shareholders’ Meeting to agree on the dissolution and liquidation of the company, and they will have to follow the aforementioned distribution procedure provided for the case involving the liquidation of the company.
  • In the event of a merger with another company or restructuring, in which shares, holdings or other assets are received in exchange for the shareholding in the company, the privileged partner would be entitled to receive shares, holdings and/or cash compensation equivalent to the amount paid upon acquiring the privileged shares/holdings (plus the interest agreed in each case). After said payment, the amount remaining, if any, would be distributed among all other partners, in proportion to their respective holding in the company’s share capital at the time of the merger or restructuring.

Given the important scope of the privileges to be granted, the fact that the venture capital investor may impose the granting of such privileges will depend on the company’s need for inflowing funds, and this is sometimes not achieved due the opposition of those partners whose consent is required.

 

For further information, please contact:

Jaime Espejo Valdelomar

jaime.espejo@AndersenTaxLegal.es

Lola Noguera

lola.noguera@AndersenTaxLegal.es

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