Opening your capital: how do you bring in an investor without losing control?

1. What you are really giving up

The figure everyone talks about is the valuation. The one that will weigh on your day-to-day is elsewhere: in the list of decisions you will no longer be able to take alone, in the terms on which the investor will be able to exit and in the personal commitments you will be asked to sign. An investor who accepts a high valuation readily makes up for it in the rights attached to its shares. Price and rights are negotiated together, at the letter of intent stage.

2. Putting the company in order before the first meeting

The investor will read your registers before your projections. It will check that every shareholder can trace their shares to a deed, that the accounts have been approved and filed, that the articles reflect every past decision and that the company actually owns what it uses: trade mark, software, domain name. Every irregularity found in due diligence comes back as a condition precedent, a specific indemnity or a price reduction. Fixing it beforehand costs less than negotiating it afterwards. That is what the firm’s corporate health check is for.

3. The letter of intent: where everything is decided

The letter of intent, or term sheet, does not bind the parties to conclude, except, as a rule, for its exclusivity and confidentiality clauses. It nonetheless frames everything that follows: amount, pre-money valuation, instrument, board composition, reserved matters, exit clauses, warranties. A point conceded at this stage is hard to reopen once the investor has incurred its due diligence costs. The term sheet should be reviewed with your lawyer before it is signed.

4. Choosing the instrument

In an established company, the investor most often subscribes for new shares, ordinary or preference shares. Preference shares (Article L. 228-11 of the French Commercial Code) carry special rights defined in the articles: priority dividend, adjusted voting rights, priority on exit proceeds. They exist only in companies limited by shares. An SARL that wants to bring in a fund first converts into an SAS.

Securities giving access to the share capital (Article L. 228-91) defer the investor’s entry into the capital: share warrants, convertible bonds. For a first round, the BSA AIR (a French share warrant comparable to a SAFE) lets the company collect funds immediately and defer the valuation to the next round, with a discount and often a valuation cap. It is quick to sign. The actual dilution, however, remains unknown until conversion, and a poorly calibrated cap makes it heavier than expected.

5. Governance: calibrating the investor’s rights

A minority investor wants a say in whatever affects the value of its investment: new share issues, borrowing above a threshold, disposals of significant assets, management pay, the annual budget. The list of reserved matters is negotiated line by line. Drawn too broadly, it pushes day-to-day management up to a committee.

6. The clauses that organise the exit

The investor comes in to get out one day. The shareholders’ agreement organises its exit and often governs yours: a temporary lock-up of the founders’ shares, a right of first refusal, a tag-along right if you sell, a drag-along obligation if an offer for the entire share capital is accepted by a defined majority. In an SAS, a lock-up clause in the articles is limited to ten years (Article L. 227-13) and can only be adopted unanimously (Article L. 227-19).

Financial clauses come on top. The liquidation preference pays the investor first out of the sale proceeds. The anti-dilution clause protects it if a later round takes place at a lower valuation. Their effect only shows at exit, in the price you receive.

7. What you will be asked to commit to personally

The founder usually gives representations about the company, sometimes a warranty against undisclosed liabilities in favour of the investor. They undertake to devote their working time to the company and not to compete with it. Above all, they accept leaver clauses: if they leave office, their shares may have to be sold, at a price that depends on the circumstances of the departure (good leaver, bad leaver). These clauses affect your personal wealth. Their duration, the applicable price and the definition of leaver events deserve as much time as the valuation.

8. Completion: the order of operations

In an SAS, a capital increase is a collective decision of the shareholders, taken under the conditions set by the articles (Article L. 227-9). In an SARL, amendments to the articles require the majorities set by Article L. 223-30. In an SAS, where the issue is reserved for a named investor, the shareholders’ preferential subscription right is waived in its favour: if the investor is already a shareholder, it does not vote and its shares are excluded from the quorum and majority calculation; the issue price is set on the report of a statutory auditor, appointed for the purpose if the company has none (Article L. 225-138). That appointment needs to be built into the timetable.

Between the term sheet and completion, due diligence, drafting and negotiating the documents take several weeks. On completion day, subscription, payment of the funds, recording of the capital increase, updating of the articles and signature of the shareholders’ agreement follow one another in an order set in advance. The formalities come afterwards.

Frequently asked questions

See also: the shareholders’ agreement; the corporate health check; the share sale

This information is general and does not constitute legal advice. Every transaction calls for its own analysis.