Shareholders' Agreement with an Investor: What You Actually Give Up

The price sits in the purchase agreement. What you are still allowed to decide on your own sits somewhere else entirely.

How a structured, discreet search works in practice is described under finding an investor.

The Gesellschaftervereinbarung (the German and Austrian shareholders' agreement) is the document owners pay least attention to when an investor comes in — and the one they feel for longest. The purchase agreement takes effect once. The shareholders' agreement takes effect every day thereafter.

It governs what you still decide alone, when you are obliged to sell alongside someone else, what happens if you want to leave, and how the proceeds are divided when the company is eventually sold.

Anyone who negotiates only the size of the stake is negotiating the smaller half of the subject.

What the shareholders' agreement governs — and what it does not

When an investor comes in, two documents are usually created side by side. The investment or purchase agreement governs the transaction itself: who acquires how many shares at what price, which warranties you give, when payment falls due.

The shareholders' agreement governs the state of affairs afterwards: the relationship between the shareholders.

It sits alongside the Satzung (the articles of association), not inside it. That is the decisive difference. The articles bind the world at large and can be inspected in the Handelsregister (the German commercial register) or the Firmenbuch (the Austrian companies register). The shareholders' agreement, as a matter of principle, binds only the parties who signed it — in return, it is not public.

For you this has two practical consequences. First, whatever exists only in the shareholders' agreement does not automatically bind a later acquirer of the shares. Second, some provisions take full effect only once they are also anchored in the articles.

Which points belong in which document is a question for your lawyer. That you ask the question at all is on you.

The question of form nobody enjoys reading

Where a shareholders' agreement contains an obligation to transfer shares in a GmbH — in a drag-along clause or a leaver provision, for instance — the formal requirement of § 15 Abs. 4 GmbHG applies in Germany: even the obligation to assign requires notarial form. In Austria, § 76 Abs. 2 GmbHG requires a Notariatsakt (an Austrian notarial deed).

A clause that fails the form requirement is not a clause. You notice that only when you try to rely on it.

The clauses that decide how freely you can act

Reserved matters and veto rights. The Zustimmungskatalog (the catalogue of matters requiring investor consent) is the list of decisions you no longer take alone. Typically: investments above a certain size, taking on outside debt, hiring and remunerating senior managers, entering into or terminating material contracts, changes to the business model, distributions.

An investor holding 25 per cent can, through a broadly drafted catalogue, effectively control the material decisions without holding a majority.

The negotiation is therefore not about whether there will be a catalogue — there will be — but about the thresholds, and about what remains possible in day-to-day business without asking first. A catalogue that captures every new hire makes a mid-sized company ungovernable.

What works well in practice is to run the catalogue against one real financial year: which decisions of the past twelve months would have required consent under this catalogue? The answer is regularly sobering — and a better negotiating argument than any abstract discussion.

Reporting obligations and the advisory board. Investors ask for reporting: monthly or quarterly figures, variances against plan, liquidity forecasts, frequently in a format of their own. On top of that there is often a Beirat (an advisory board) with an agreed allocation of seats and its own powers.

Both are legitimate and, in substance, useful. It is the workload that gets underestimated. If your finance function currently delivers six weeks after quarter end, a contractually promised report within ten working days becomes a recurring source of conflict.

Settle before signing who actually prepares these reports and what that costs.

Tag-along and drag-along: allowed to go, obliged to go

These two clauses decide whether you are master of the situation when the company is later sold.

Tag-along — the right to sell alongside. If one shareholder sells his shares, the others may sell on the same terms. The clause protects the minority shareholder from being left behind with a new majority shareholder he did not choose.

If you hold the minority after the investment, this is your clause. Make sure it refers to the same price per share and not merely to a pro-rata slice of the package being sold.

Drag-along — the obligation to sell alongside. If the majority shareholder finds a buyer for the entire company, he can force the minority to sell its shares too. Without this clause a single shareholder could block a sale — which is why investors regularly insist on it.

For you as a remaining minority shareholder this means: you can be forced into a sale you do not want, at a moment you do not choose.

What is negotiable are the conditions. Common terms include a minimum holding period before the clause bites, a minimum price or minimum valuation, equal treatment on price and warranties, and a cap on the warranties you have to give as a co-selling shareholder.

The last point is the one most often overlooked. A drag-along clause without a liability cap can mean that you stand behind warranties whose wording you never negotiated.

Liquidation preference: why your percentage is not your share of the proceeds

A liquidation preference gives the investor the right to receive a defined amount first in a sale — usually the capital he invested, sometimes a multiple of it, frequently plus interest. Only the remainder is then distributed pro rata.

The consequence: with a 30 per cent stake, the investor does not necessarily receive 30 per cent of the proceeds. In a sale below expectations he can receive by far the greater part, while the founder sees little despite holding the majority.

Two variants have to be distinguished. Under a participating-with-credit preference, the amount received up front is set off against the later pro-rata distribution. Under a non-credited preference the investor receives both — the up-front amount and, on top of that, his full percentage of the remainder.

The difference sounds technical. In mid-range sale scenarios it decides six- to seven-figure amounts.

Run every proposed preference through three scenarios: a sale below the entry valuation, a sale at entry level, a sale well above it. If a clause only looks fair in the best case, it is not fair.

What happens if you want to leave

Investors who depend on your continued involvement protect themselves. The instruments are called vesting and leaver clauses.

Under vesting you earn part of your own shares over time — or a call option over them lapses over time. Anyone who leaves early forfeits the unvested part or has to hand it over at a reduced price.

Leaver clauses distinguish according to the reason for departure. Good leaver status usually covers illness, reaching retirement age, death, or termination by the company without cause; bad leaver status covers early resignation by the individual or a serious breach of duty. The good leaver receives fair market value, the bad leaver a discount — in extreme cases only nominal value.

The boundary between the two categories is the real subject of negotiation. Wording that turns a simple disagreement over strategy into cause for termination is not a theoretical risk.

Check as well how fair market value is determined in the leaver case. A reference to a defined procedure and an independent expert is worth more than any assurance. Which methods come into question is set out under company valuation.

The investor's exit rules are your timetable

Financial investors work to fund terms. They invest in order to exit again within a foreseeable period. That expectation is rarely stated in the contract as plainly as it shapes the working relationship.

In the shareholders' agreement it appears in clauses on exit preparation: the right to launch a sale process from a certain date, obligations on the other shareholders to cooperate, occasionally an obligation to support a stock market listing.

If you plan to run the company for another ten years and the investor wants to sell after five, that is not a detail but a fundamental conflict of objectives. It belongs on the table before the investor is selected, not during contract negotiation.

How the investor types differ on this point is described under strategic buyer or financial investor and financial investor.

Where minority shareholders actually have protection

The most effective protection comes not from the number of clauses but from three points.

First: information rights that go beyond the statutory minimum and follow a fixed rhythm. Anyone who first learns at the shareholders' meeting what has happened cannot react.

Second: qualified majorities for fundamental matters set out in the articles — not merely in the side agreement. Capital increases, changes to the corporate purpose, mergers.

Third: a procedure for the case of deadlock. Escalation stages, mediation, and as a last step a defined put or exit right at a price determined by an agreed procedure. Agreements without an exit mechanism tie both sides into a conflict neither of them can end.

What you should have settled before the first negotiation

Four questions whose answers determine your negotiating position — and which you can only answer honestly without time pressure.

How much longer do you want to run the company? That answer determines which investor types come into question at all.

Which decisions do you have to be able to take alone for the business to work? That is the basis for negotiating the catalogue of reserved matters.

What happens if you drop out — can the company be run without you? Anyone who solves this question beforehand negotiates leaver clauses from a different position.

And: what does the distribution of proceeds look like in a middling scenario, not in the best one? Work it through before you talk about valuation.

Negotiating a shareholders' agreement is rarely a legal dispute. It is a dispute about expectations that are subsequently written down in legal language. Those who know their own expectations negotiate better.

How we support owners in selecting and approaching investors is set out under finding an investor.

FAQ

Do I need a shareholders' agreement if I keep the majority?

Yes. Even as majority shareholder, it is where you set out what say you grant the investor and on what conditions shares may later be transferred. Without an agreement, only statute and the articles apply — and both have little to say on the questions that typically become contentious between two shareholders.

What is the difference between the articles of association and the shareholders' agreement?

The Satzung is the constitution of the company: publicly inspectable and effective against everyone. The shareholders' agreement is a contractual arrangement between the shareholders: not public, but in principle effective only between the signatories. Some provisions need both documents in order to work.

Can I refuse a drag-along clause?

Refusing it outright is rarely possible against an investor. What is negotiable are the minimum holding period, a minimum price, equal treatment on price and terms, and a cap on the warranties you give as a co-selling shareholder. In practice that is where the real room for manoeuvre lies.

Does a shareholders' agreement have to be notarised?

Not necessarily in its entirety. If it contains an obligation to transfer GmbH shares, however, the formal requirements apply — § 15 Abs. 4 GmbHG in Germany, § 76 Abs. 2 GmbHG in Austria. Since such obligations are regularly contained in drag-along and leaver clauses, the agreement is frequently notarised in practice. The assessment in the individual case is for your lawyer.

What is a liquidation preference and is it common in the Mittelstand?

It gives the investor an up-front amount in a sale before the remainder is distributed pro rata. It is most widespread in growth financings and in minority investments by financial investors. What matters is whether the up-front amount is set off against the later pro-rata distribution — that is the difference between downside protection and redistribution.

When should I negotiate the shareholders' agreement?

As early as possible, ideally already at term sheet stage. Anyone who negotiates the valuation and defers the shareholders' agreement negotiates the second part with nothing left to trade — the material concessions have already been made.

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Selling a company is the most important transaction of an entrepreneurial life. Take independent, discreet advice — IGCP Capital Partners. → igcp.at