Venture Capital Financings

1. Venture Capital Financings: Drag Along Rights If you are a venture capitalist planning to invest in a new startup company, you must ensure that the company’s shareholder agreement contains the provision of drag- along rights. What are Drag Along Rights? Drag along rights under shareholders agreement is a provision that gives a majority shareholder the right to force minority shareholders to sell their shares if the majority shareholders decide to sell their shares. It is an agreement that is made with all the shareholders in a company. The provision protects the majority shareholder from other shareholders who might wish to abandon the company. Instead of selling their shares, they would rather wait for a higher price. This provision is called the drag along rights as it drags the decisions of the other minority shareholders to take the decision favored by those who hold most of the stake in the company. Drag-along rights are usually included in a shareholder agreement to ensure that minority shareholders agree with any decisions made by majority shareholders. If shareholders do not want to be forced into selling their shares, they should ensure that there is no drag-along provision in the agreement.

2. Drag Along Rights and its meaning in Venture Capital Financings? Investors usually have drag-along rights, which allow them to force other investors in the company to sell their shares when they want to sell theirs. The idea behind these rights is that if one investor wants out, it is better for everyone if they can all get out at once. Drag-along rights for venture capital are typically found in agreements between venture capitalists and startup companies. They are used as an incentive for investors to invest in startups, because without this provision, investors may be less likely to invest in startups where there is a risk of losing control of the company. In any venture capital transaction, the venture capitalist needs to ensure that there is drag along rights provisions in the shareholder agreement. Without this provision, if one of the shareholders decides to sell their shares, they will not be able to force other minority shareholders to sell theirs. Drag-along rights allow the venture capitalists to compel the entrepreneurs to take actions they might not otherwise want to do, for instance, selling the company or selling their stake to another company. What are the key terms of a typical VC Financing’s Drag Along Provisions? The typical VC financing’s drag-along provisions are the following: the VC has the right to simultaneously force all the shareholders to sell their shares to a third party. ▪ if any shareholder does not agree with this sale, they will be bought out for what is called fair value. ▪ some VCs include a provision that if one shareholder agrees to sell their shares, this agreement will also apply to all other shareholders. ▪

3. in some cases, there might be an option for an early buyout before the company goes public. How do Venture Capital Drag Alongs work in practice? ▪ The drag-along clause is often used by venture capitalists who invest in companies with dual-class shares. Dual-class shares are shares that have more voting rights than other shares. A company may issue dual-class shares to founders, investors, and employees as part of their compensation packages. The use of the drag-along provision can be contentious because it does not allow the company’s board of directors to stop the sale of an investor’s stake in the company if they do not want it to happen. This provision is usually used when the majority shareholders want to sell their shares and needs approval from other shareholders. Why do Investors use Venture Capital Drag-Along Rights to protect their investments? In the world of startups, it is common to see investors invest in a company with the hope that they will make a return on their investment. However, not all investments are successful; sometimes, the company fails. When this happens, investors may be left with nothing to show for their investment. To protect themselves from this risk, investors use venture capital drag-along rights to ensure that they get some of the profits when an investment succeeds and some of the losses when an investment fails. Investors can use venture capital drag-along rights to protect themselves from risk and ensure that they get some of the profits when an investment succeeds as well as some of the losses when an investment fails.