A Participation agreement is a legal agreement that sets out the terms and conditions of an investment in a company. In the context of start-up funding, it specifies, in particular, how much capital investors are to provide, what shares in the company they will receive in return, and the conditions under which the investment is made.
The agreement thus provides a binding framework for financing. At the same time, it helps founders and investors to clearly set out their respective expectations and obligations.
What should be included in a shareholding agreement?
The exact details depend on the funding round and the agreed equity structure.
Typical elements of a contract include:
- Amount invested: How much capital are the investors providing?
- Company valuation and ownership stake: What valuation is used as a basis, and what shareholdings result from it?
- Capital increase: How are new shares issued?
- Conditions of enforcement: What conditions must be met before the financing can be arranged?
- Representations and warranties: What explanations do the company and, where applicable, the founders provide?
- Rights to information: What company information should investors receive?
- Right to be consulted: For which decisions might founders need approval?
- Exit arrangements: What conditions apply in the event of a subsequent sale of shares in the company?
Not all provisions need necessarily be set out in the actual investment agreement. The terms are often set out across several related documents.
How does a share subscription agreement work for start-ups?
Before any funding is finalised, the start-up and the interested investors negotiate the key terms.
These are often set out initially in a term sheet. The parties then carry out due diligence on the company and draw up the final contracts.
A typical procedure involves:
- Hearing: Both parties agree on the investment amount, valuation and key terms of the investment.
- Drafting of contracts: The parties involved arrange for the necessary documents to be drawn up and checked.
- Signing and notarisation: They conclude the contracts in accordance with the applicable formal requirements.
- Closing: The parties involved shall comply with the agreed conditions for implementation and arrange the necessary funding.
The specific procedure also depends on the company’s legal form and the nature of the shareholding.
Example: Investment in a B2B start-up
A start-up is developing software to automate industrial production processes.
The company intends to raise one million euros in capital to expand its sales operations.
The parties have agreed on a pre-money valuation of four million euros. In a straightforward equity round, this results in a post-money valuation of five million euros.
The new investors will therefore receive, in mathematical terms, 20 % of the company’s shares.
The investment agreement sets out, amongst other things, the amount of the investment, the implementation of the capital increase and the agreed conditions for completion.
The parties may set out additional rights – for example, regarding the disclosure of information or the subsequent sale of shares – in a supplementary shareholders’ agreement.
What is the difference between this and a shareholders’ agreement?
The shareholding agreement, also known as Investment Agreement ... is primarily focused on implementing the investment.
The shareholders’ agreement (Shareholders‘ Agreement) governs, on the other hand, the long-term relationship between the shareholders.
These may include, for example, voting agreements, rights to information and provisions governing the sale of shares in the company.
In practice, companies often combine these two areas of the contract into a single Investment and Shareholders‘ Agreement.
It is also important to distinguish these from the articles of association or the company’s statutes. These documents fulfil distinct functions under company law.
What risks should start-up founders be aware of?
A carefully drafted contract can minimise misunderstandings. However, founders should carefully consider the long-term implications of individual clauses.
The following deserve special attention:
- Dilution: How do new funding rounds affect ownership stakes?
- Liquidation preferences: Which investors might be given priority when it comes to receiving proceeds from an exit?
- Right to be consulted: Which decisions can the founding team continue to make independently?
- Warranties and liability: What obligations and potential personal risks are involved?
- Transfers of shares: What restrictions apply to a subsequent sale?
Notarial formal requirements may also be relevant, particularly in the case of a German GmbH. Founders should therefore have the contractual documents reviewed by a specialist solicitor before signing them.
You can find further information on standardised funding templates in the innoWerft article GESSI standard contracts for more efficient start-up financing.
How can innoWerft help with this?
innoWerft helps founders to develop funding strategies, gain a better understanding of investment models and prepare for discussions with potential investors. Through coaching, start-ups can assess the financial implications of various funding terms; however, this is no substitute for a tailored legal review of the contract.
Frequently asked questions about the shareholders’ agreement
What is the difference between a term sheet and a share purchase agreement?
A term sheet sets out the key points of a planned financing arrangement and is often largely non-binding. The investment agreement, on the other hand, sets out the binding terms and conditions for the implementation of the investment.
Does a shareholding agreement have to be notarised?
That depends on its content and the legal form of the company. In the case of a GmbH, capital increases and obligations to transfer shares, in particular, may require notarisation.
What rights do investors acquire under a share subscription agreement?
Depending on the terms of the agreement, investors may, for example, be granted rights to information, oversight or a certain degree of influence. The exact scope depends on the contracts and the ownership structure.
Can shareholding agreements be amended at a later date?
In principle, the contracting parties may agree to make amendments. In doing so, however, they must comply with the existing provisions and, where applicable, statutory formal requirements.
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