We have identified 5 pitfalls to avoid when considering an investment offer from a corporate investor who could have conflicting interests

Choosing your shareholders carefully is essential. Active shareholders, or so-called “sparring partners”, not only help define and implement good governance to achieve the desired growth ambitions, but also open doors, thanks to their network or their knowledge of the market.

Receiving a sign of interest from a customer, supplier, or key partner (“corporate investor/shareholder” ), is often perceived as a strong recognition of the added value created the venture, and this is indeed generally the case.

However, there are several issues to consider to ensure that interests are, and will remain, aligned.

While in most cases the intentions of your potential corporate shareholder will be laudable and constructive, knowing the risks and how to mitigate them is essential.

One of TheClubDeal’s credos is to form alliances, i.e. to align the interests of all parties as much as possible to achieve the same goals together.

This article will list some examples of risks that can be created by a corporate shareholder with whom interests have not been fully aligned upstream and will list some proposed solutions.

These examples remain generic, and readers wishing to challenge their strategy upstream or after welcoming such a shareholder are welcome to contact the team of TheClubDeal, for a more in-depth sharing of experience and to define an optimal interest alignment strategy.

Some risks of misalignment of interests can, for example, lead to the following destructive cases where the corporate shareholder unilmaterally seeks to :

1. Gather Information
2. Burry the technology, service or innovation
3. Abuse commission fees
4. Majority hold-up
5. Boycott the potential interests of competitors

Information gathering

Being a shareholder in a company can be a way for a corporate investor to test and learn about a market or a product with almost no risk. In the most critical situations, it is not impossible to see shareholding as a way to access sensitive data or any other information, sometimes confidential, that the shareholder would not have had otherwise.

To avoid these situations, it is recommended to establish upstream the framework and frequency of the information that will be transmitted to shareholders, in the “information rights” section of the shareholders’ agreement.

Putting the service or technology on the back burner to drive out the competition

If the venture starts to or risks to canibalise the market of the corporate shareholder, it could influence the venture to wind-down its operations through various methods. Although this practice is generally reprimanded by competition authorities, it is always important to understand the intentions of the transaction.

In particular, starting the drafting of the shareholders’ agreement by writing all of the “whereas” is good practice to confirm/mutualise intentions and to push for transparent communication on the long-term intentions of the parties.

Obtaining disproportionate referral fees

It is not uncommon to see shareholders or directors helping entrepreneurs expand their network and introduce them to commercial prospects. If a commission system exists, it is advisable to establish it early in the relationship, that it is well communicated, validated by the board of directors, and that it is on the same terms between all parties.

Have a gradual takeover on terms that would harm the interests of the founders or other shareholders

As explained above, ensuring a perpetual alignment of interests is essential. Appointing an independent director (or an independent chairman) maximizes the chances that the company’s interests will be put first and ensures proper governance.

Boycotting the interest of new investors, especially investors competing with the corporate shareholder

This is the situation in which an investor decides to take a stake in a company not for capitalist reasons or potential future strategic synergies, but rather to prevent any future relations with its competitors, and thus maintain a monopoly and control over the company, the alliance of which could create a competitive advantage for a particular player. It is important to identify the pre-emptive rights and other blocking clauses that would be proposed by the shareholder. The blocking percentages or obligations linked to these clauses should be analyzed in the context of the capitalization table to understand the possible future blocking scenarios.

In general, one should be wary of a very large player who wishes to take a share in the capital of a small company, without clearly formulating its long-term intentions. This is all the truer if the investment corresponds to a negligible fraction of his available financial resources, and therefore the impact of the success or failure of the investment does not affect him, and if he does not wish to be strategically involved in the development of the project by demonstrating his added value as a shareholder or director. Conflict resolution protocols exist and have determined a set of exit scenarios is highly recommended.

In conclusion, transactions involving corporate shareholders are double-edged swords but can be mitigated thanks, namely, to a well drafted shareholder’s agreement. We invite you to carefully consider all possible senarios, both favorable and unfavourable as well as the risks and benefits of their investment to form a solid and lasting alliance.

At TheClubDeal, we do not compromise on governance, and we remain at your disposal for any questions you may have, or simply to share your experience and think together to maximize alliances with your corporate shareholders.