Terms and conditions of venture capital transactions: reserved matters
- Reserved matters
- What are reserved matters for?
- Decision-making levels: OSA or board
- How can funders protect their interests?
Last time, we told you about what financing options are available in venture capital deals, as well as the paperwork that goes along with making an investment.
Today, as in subsequent articles, we want to talk about the complicated: what the key terms of the deal documents are, how they work, and what you can negotiate with the investor. Understanding all of the above will give you the opportunity to discuss the terms of the deal with the investor from the outset to ensure that it is in the best interests of both parties and thus build a partnership.
Let's start our introduction to the content of transaction documents with such an instrument as reserved matters.
Reserved matters
Reserved matters are a list of the most important issues related to the conduct of the company's business that are subject to the decision of the General Meeting of Shareholders (or the Board of Directors) and, as a rule, cannot be made without the approval of the investor. In simple words, reserved matters give the investor the ability to block decisions on specific issues (i.e. veto power).
Reserved matters is one of the key terms of the transaction related to the conduct of the business after the investor enters it.
What are reserved matters for?
Reserved matters is essentially a mechanism of investor control over the startup's business conduct on control and most important points, i.e. issues, wrong decisions on which entail high negative risks for the business.
As a general rule, decisions in a company are made by a simple majority of votes (i.e. 50% +1). At the same time, the legislation of many countries establishes lists of issues that require a qualified majority of votes (2/3, 3/4) or unanimity.
However, in a venture capital transaction, such questions are usually not enough for the investor. Thus, the list of reserved mattes expands them.
When establishing reserved matters, the transaction documents (shareholders' agreement, voting agreement) fix a different order of decision-making on such matters than 50%+1.
For example, it may be stipulated that in order to take a decision on a matter that falls within the scope of reserved matters:
- the investor's affirmative vote OR
- Having a set percentage of positive votes (e.g. 80 per cent or more of all votes).
In this way, the investor receives a guarantee that a decision on the list of reserved matters will not be taken if the investor is against such a decision. This does not give the investor the opportunity to decide on the matter independently and alone, but only the opportunity to block an undesirable decision.
Decision-making levels: OSA or board
Most often, the governance structure in startups is two-tiered: some decisions are made by the director and some by the general meeting of participants/shareholders (GM).
Generally, decisions on reserved matters are submitted to the general meeting of participants (due to their importance). But sometimes, in order not to delay the decision-making process on some issues, the investor may initiate the creation of a board of directors (bord) in the company. The board usually includes representatives of the parties to the transaction, i.e. directors appointed by the funders and appointed by the investor.
Further, the board of directors is delegated a part of the matters referred to reserved matters. Decisions on these should be made by the board with a mandatory vote in favour of the investor-appointed director.
Which issues are most often referred to by the investor?
There is no standard list of reserved matters, it depends on the transaction itself. However, as we have already mentioned, they include the most important issues that affect the business and may have negative consequences for the company (loss of assets, emergence of large debts). Thus, in our experience, investors most often fix the following key blocks of reserved matters:
- making amendments and additions to the company's constituent documents, changing the amount of the company's authorised fund
- company reorganisation/liquidation
- admission of new members to the company
- Disposal of intellectual property (IP) rights by a company
- attracting additional investment or financing for the company
- changes in the company's management procedure, defining and changing the main directions of the company's activities
- dividend distribution issues
- approval of key employees, approval or amendment of any option programmes;
- Pivot (change in the direction of the company's business);
- entering into large transactions (usually of USD 100K or more);
We repeat that this list is not exhaustive and is of an introductory nature for a better understanding of the tool's operation.
How can funders protect their interests?
Undoubtedly, funders are more interested in attracting investment than anyone else and may be willing to sign up for anything. However, we do not recommend rushing into it. Analyse the transaction documents in detail, including such an important block as reserved matters.
If you disagree with something, don't be afraid to enter into a discussion with the investor. The main thing is to be able to justify your position.
For example, if an investor sets a block on deals from 20 000 USD, considering it a large deal, and you have such a deal as an ordinary one, it is quite logical to offer the investor win-win conditions and increase the threshold.
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