Investors in early stage companies have certain rights based on the laws that govern companies and investments. Some of these stem from company law and are set out in a company’s articles of association (a constitutional document that sets out a company’s purpose and the way it is managed and administered), while others take the form of contractual protections which are typically contained in a company’s shareholders agreement.
Seedrs has a dedicated team of experienced and passionate lawyers that negotiate these documents on your behalf, only approving campaigns on the Seedrs platform where the company has put in place an appropriate suite of minority shareholder protections.
In this guide we’ll run you through some of those key investor rights that Seedrs requires and what these mean in practice for you, including:
- Share class rights
- Pre-emption rights
- Information rights
- ‘Investor Majority’ consents
- Founder Restrictive covenants
- Tag-along rights
Background – The Seedrs Nominee Structure
What is a nominee and what is the Seedrs nominee structure?
At its simplest, this is a legal term for a person (or company) who holds shares on behalf of others. Seedrs holds the shares in our portfolio companies on behalf of our investors. While Seedrs will be registered as the legal shareholder in the company and take care of all the administrative shareholder work on your behalf, the full economic interest in the shares will always flow back to you.
As nominee, Seedrs is generally empowered to take decisions on behalf of our investors as a whole, and will always act in their best interests with the intention of (a) maximising potential returns, and (b) ensuring that investors are being treated equitably. We do not typically pass votes back to individual investors unless there is a choice that needs to be made by each individual investor (e.g. exercising available pre-emption rights on a future fundraising, or an offer to purchase shares from Seedrs that is not part of an exit or mandatory sale).
For more on the advantages of the Seedrs Nominee structure for both investors and companies alike, you can explore the topic in more detail here.
Share class rights
The first major source of investor rights stem from the class of shares they invest in. All share classes have rights associated with them, and these will vary depending on the relevant company’s constitutional documents.
What are the most common share classes?
As companies grow and become more sophisticated, they often create more than one class of shares. The variations amongst share classes usually focus on control (voting, consent rights etc) and economics (capital returns on investment).
Two of the most common share types are below:
This is the most common share class in early-stage companies, and typically entitles all holders to voting, dividends (if declared) and capital distribution rights).
With a single class of ordinary shares, these rights are generally proportionate. For example, if a shareholder held 10 shares out of 100, he or she would be entitled to 10% voting rights and ownership of the company.
Importantly, for S/EIS qualifying companies, ordinary shares are also usually the eligible share class from a tax compliance perspective.
This share class ranks ahead of ordinary shares in some way when it comes to economic returns. Typically, preference shares will have a liquidation and/or exit preference, but may also have:
- Anti-dilution rights: where a shareholder automatically gets issued more shares if there is a down-round;
- Weighted voting rights: where a shareholder gets more than one vote per share; and
- Preferential dividend rights: where a shareholder receives a dividend ahead of other junior classes.
This type of share class is often sought by institutional investors and can invalidate an investor’s SEIS/EIS tax benefit depending on how it is structured.
What share class rights will Seedrs investors receive?
This will depend on the Seedrs campaign in question and what is being offered as part of the round. Where companies have different share classes that could impact a future return for Seedrs’ investors, these will always be set out in the “Key Information” section of the campaign.
Regardless of what class is being offered, Seedrs will always ensure that:
- 1. The relevant share class has voting rights – this enables Seedrs to vote on your behalf and be given notice of key company actions.
- 2. Any investment reflected in the campaign progress bar is on the same terms as those offered to Seedrs investors. In the event there is a legitimate commercial reason for accepting something different (eg. both preference and ordinary shares are being issued, but only ordinary shares are S/EIS eligible), that will be clearly set out in the Campaign page.
Below are some of the key investor protections that Seedrs’ team of in-house corporate lawyers seek to ensure are in place prior to transferring funds on any campaign:
What are pre-emption rights?
If a company wants to issue new shares, pre-emption rights afford existing shareholders the right to buy these new shares, on the same terms, before they are offered to new investors.
Why are pre-emption rights important?
Pre-emption rights mean that existing shareholders have the chance to preserve their shareholding percentage and avoid that being reduced as a result of more shares being issued to external investors (known as ‘dilution’).
This becomes even more important in circumstances where the company is not performing well and needs to raise further investment at a lower valuation (i.e. issue more shares for a lower share price, increasing the dilutive impact).
Will pre-emption rights apply to every raise that the company I’ve invested in does?
Not necessarily. Sometimes it will be important for pre-emption to be waived in order for an incoming investor to acquire a specific percentage of the company. In this scenario, it is common for pre-emption to be waived for all by a shareholder majority vote on the basis that the longer term value of the new investment will outweigh the value of being able to maintain current percentage holdings.
How do Seedrs investors take up pre-emption?
Unless pre-emption has been waived (see above), Seedrs will notify you of the pre-emption opportunity and invite you to participate via a private pre-emption page on the Seedrs platform. This is not an obligation but simply a right to participate and it is completely your choice whether to do so or not.
Simply being a shareholder in a company does not generally entitle an investor to many rights to information about the company itself. For that reason, Seedrs ensures that all of its investee companies’ legal documents contain contractual information rights which:
- Ensure that Seedrs can meet its legal and regulatory duties as a nominee; and
- Oblige the company to provide Seedrs’ investors with an update on the business via the post-investment pages at least once a quarter.
For more detail about these information rights and the rationale behind them, please see here.
“Investor Majority” consents
What is ‘Investor Majority Consent’?
When many investors invest in a company, they usually do so without getting any sort of day-to-day control. That means that they are often placing their money in the hands of someone else.
A company is managed by its board of directors, which, in early-stage businesses, is usually controlled by the company’s founders. In many cases, Founders will also hold the majority of shares in the business – meaning they have complete voting control at both board and shareholder level.
The concept of “Investor Majority Consent” exists to ensure that there is an appropriate check on certain key company actions. In practical terms, this creates an additional layer of consent that must be given by a wider group of shareholders before a company can carry out certain actions, ensuring that third party investors can have a say on certain matters that could affect the value of their investment.
This is a market standard investor protection that Seedrs seeks to include in any investment documents, although its scope can vary depending on the stage of business and existing investor base.
What actions require Investor Majority Consent?
Seedrs asks for a select number of consent actions to be subject to Investor Majority Consent. These are all value orientated, in that they go to the value of your investment and potential returns. Seedrs does not generally require operational matters to be subject to Investor Majority Consent.
This approach strikes a balance between allowing the team in which you invested to manage the business efficiently, whilst also providing a layer of protection to ensure your investment is dealt with appropriately.
Founder Restrictive Covenants
What is a restrictive covenant?
A restrictive covenant is simply a contractual promise not to do something. They can cover all sorts of scenarios, but the key one Seedrs requires is a ‘non-compete’ covenant binding the founders of the business. This means that founders are precluded from directly competing with the company you’re investing in for the duration of their involvement, and for up to 2 years afterwards.
Why does Seedrs require non-compete restrictions?
The value and risk of early stage investment primarily centers on the Founders and their experience or vision. If they were to leave the company for a competitor, that would likely have a significant impact on the prospects of the company. The non-compete covenant therefore ensures a founder remains committed to growing their company and your investment.
What are tag-along rights?
A tag-along right is the right of a minority shareholder to sell his or her shares when the majority of shareholders are also selling their shares, usually in an exit scenario.
Why is tag-along beneficial to minority shareholders?
Tag-along is a protection because it may provide you with a more valuable exit. In other words, minority shareholders are likely to get a better deal if they sell at the same time as the majority of shareholders (e.g. founders) than they would if they were to remain on the cap table and attempt to sell their shares separately down the line (without any guarantee of another exit opportunity).
Investors should always keep in mind that negotiating pressure can be heavily exerted on companies in future funding rounds by incoming investors – and often the decision is one of agreeing to their proposed terms or rejecting the (often business critical) funding.
It is standard practice that as companies grow and take on further investment, incoming investors may require that the company’s existing shareholder documents be replaced. Existing shareholders are also likely to have less leverage and voting power, particularly if they do not follow-on in future rounds.
Investors should therefore be conscious that the level and strength of contractual rights that Seedrs can put in place will depend on a number of factors, including the stage of the company and size of investment, and such rights will most likely change over the lifetime of the investment. For this reason, we cannot ‘guarantee’ any particular rights for investors, but our team of in-house corporate lawyers are constantly reviewing and negotiating to ensure Seedrs investors are being treated fairly.