Corporate Law: The relationship between the investment documentation and articles of association of a start-up
As a rule, numerous agreements will be negotiated and concluded between the existing shareholders and new investors in connection with financing rounds. These include the investment agreement (in the narrow sense, setting out the terms of the investment of the investor) and the shareholders' agreement. The articles of association of a start-up are normally recast or at least amended in relation to the execution of an investment. While only excerpts of the investment and shareholders' agreements need to be submitted to the commercial register, if any, the articles of association of start-ups are publicly available in the commercial register and can be accessed by anyone.
As the parties normally wish to keep certain details of the financing round confidential and depending on the content of the articles of association additional costs for notarial recording and filing with the commercial register occur, there is often a question of which elements of the investment documentation need to be included in the articles of association. This column examines this tension.
1. The investment agreement
The investment agreement establishes the conditions for the investor’s investment, in particular the extent of the participation, the valuation and amount of the investment (supplementary payments or premiums in addition to the nominal contribution), maturity (closing conditions, milestones), rules for future changes to the shareholding structure (anti-dilution, ratchet) and a catalogue of guarantees and warranties made by the founding shareholders.
2. The shareholders' agreement
In contrast, the shareholders' agreement (in addition to the articles of association) deals with the future relationship between the shareholders. It establishes the rights of specific shareholders to have representatives on the executive or advisory boards, extends the information and approval rights of investors beyond the statutory standards, and establishes exit rules (restrictions on the transfer, tag-along rights, liquidation preferences, etc.) and management commitments (vesting rules and non-compete clauses). As a rule, this agreement is concluded by all shareholders as a single agreement.
3. Mandatory elements of the articles of association
Some of the typical areas of regulation mentioned above (even if only indirectly) must be included in the articles of association of the start-up in order to be effective. This is true when the start-up takes the legal form of a limited liability company (Gesellschaft mit beschränkter Haftung, GmbH). If the start-up is established as a stock company (Aktiengesellschaft, AG) or takes this legal form, the requirements are even stricter. Due to the frequency of use of the GmbH form for start-ups, we will now focus only on the requirements of this legal form.
3.1 Starting point: mandatory and non-mandatory statutory requirements
The starting point for the catalogue of areas to be regulated in the articles of association of a GmbH are §§ 3 para. 1 and 5 para. 4 of the German Limited Liability Companies Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung, GmbHG). According to these provisions, the articles of association must include the following elements:
- The company’s business name and the place of its registered office.
- Purpose of the company.
- Amount of the share capital.
- Number and nominal value of the shares (only applying to the formation phase).
- Obligations of the shareholders vis-à-vis the company in addition to the payment of the capital contribution (this also affects so-called issuing premiums, providing that these shall have effect from a corporate perspective).
- The object of any non-cash contributions and the nominal share value assigned to those non-cash contributions.
- Any specific term for which the company is formed.
In addition, the GmbHG establishes a number of specific elements; only the articles of association may include reservations or differing rules with respect to these elements:
- The transfer of shares, where this should have the effect of a right in rem (§ 15 para. 4 GmbHG).
- Facilitation of a shareholder resolution about the obligation to pay additional con-tributions (§ 26 para. 1 GmbHG), deviations from the statutory rules on obligations to pay additional contributions (§ 28 GmbHG).
- Deviations from the statutory rules on the allocation of earnings (§ 29 GmbHG) or on the ratio of distribution for assets upon liquidation (§ 72 sentence 2 GmbHG).
- The redemption of shares by the company (§ 34 para. 1 GmbHG).
- Deviations from certain statutory rules on the executive board (§§ 35 para. 2, 37 para. 1 and 38 para. 2 GmbHG).
- Deviations from the statutory provisions on the rights of shareholders vis-à-vis the company arising under §§ 46 to 51 GmbHG (§ 45 para. 2 GmbHG).
- Formation of a supervisory board (§ 52 para. 1 GmbHG).
- Changes to the majority requirements for amendments of the articles of association and for the winding up of the company (§ 53 para. 2, § 60 para. 1 no. 2 GmbHG).
- Creation of authorised capital (§ 55a GmbHG).
- Stipulation of other grounds for winding up the company (§ 60 para. 2 GmbHG).
- Stipulation of a liquidator other than the directors (§ 66 para. 1 GmbHG).
3.2 Grey zone with contractual agreements
It should be noted that it is also possible to conclude a purely contractual agreement – not an agreement under company law – that is not part of the articles of association with respect to some of the matters mentioned above, in particular in the following areas:
- The payment of the premium upon the issue of shares. This is definitely the norm when conducting a financing round because it will prevent the valuation of the start-up from being made publicly available in the commercial register.
- Restrictions on the ability to dispose of shares.
- The establishment of an advisory board, where this board is not granted the powers of an organ of the company and limits its activities, for example, to providing advice.
- A profit allocation formula that deviates from the statutory rule; the same applies to the distribution of assets in the case of liquidation.
However, any contractual deviation from the statutory provisions only binds the contractual parties themselves.
Conversely, certain rules, which may only be contractually agreed and which go beyond the mandatory levels, should also be reflected in the articles of association, such as, for example:
- Drag along obligations, rights of first refusal, etc. in connection with a share transfer stipulation.
- Rules related to the mandatory redemption of shares on settlement so that these are binding on all shareholders – including future shareholders.
- Rights of approval for investors with respect to shareholder resolutions.
- Non-compete obligations.
In light of the legal and contractual framework that includes the investment agreement, shareholders' agreement and the articles of association, an analysis should be made of which elements must be included in the articles of association in line with the mandatory statutory provisions, as these will be made publicly available in the commercial register and may result in additional costs. Furthermore, it can also be advisable to include certain rules in the articles of association - which go beyond the mandatory levels - although this is not required.