Term Sheet (4) Drag-Along and Co-Sale｜What if the founder and investor can't reach an agreement?
The most important exit channel for VCs is for startups to be acquired. However, when a startup is about to be acquired, it usually has several rounds of investors, and the opinions of each round of investors are not always the same, so two clauses are necessary: one is Drag-Along, and the other is Co-Sale.
1. Drag-Along
When an investor tries to find a suitable M&A partner, the founders or other investors may not agree with the M&A partner or the M&A offer, the terms of the M&A, etc., making it difficult for the M&A deal to proceed.
A typical drag-along right clause in venture capital terms is as follows:
Drag-Along Right: Prior to a Qualified Public Offering, if a majority of the holders of Series C Preferred Shares agree to sell or liquidation of the Company, the holders of the remaining Preferred Share and Common Share shall, if applicable, be required to approve such transactions and, ifapplicable , to sell the shares at the same The holders of the remaining Preferred Shares and Common Shares shall, if applicable, be required to approve such transactions and, if applicable, to sell the shares at the same price and upon the same terms and conditions.
There are advantages and disadvantages to the Drag-Along clause.
a. Pros: In Chinese M&A, the acquirer often wants to achieve maximum leverage with the usual money by holding 51% as the majority shareholder in many companies, while in US M&A transactions, the acquirer usually wants to acquire a complete company with 100% of shares, not some old shareholders' power remaining. So this time if there are one or two uncooperative old shareholders not willing to sell shares, it is likely that the deal will not be cLosed . Therefore, it is reasonable that if the majority of shareholders of a company decide to sell the company, a few minority shareholders should not stop the deal, nor should they have the means to do so.
b. Cons: the terms of the Drag-Along is often a majority of the current round of investors can approve the resolution to sell the company. As mentioned above, a majority of Series C investors agree, the other investors and founders need to agree. So it is possible that the C-round investors will sell the company at a low price in bad faith to an acquirer who has an interest in the C-round investors, from which they can reap the benefits.
For example, The terms of Drag-Along in Guo Jing's North Warrior Technology in each round of financing is the most conventional. That is, when it comes to Series A Financing, A round of investors have the Drag-Along right, and B round of investors and C round of investors are also the same. Therefore, C round of investors, Beggar Capital also has the Drag-Along Right. Suppose one day GP Hong Qi Gong said, anyway, your North Warrior Technology's co-founder, Huang Rong, also took over the beggar's sect, then I see you can directly make our Beggar Capital acquire it. That the first few rounds of investors certainly do not agree, the Mongols that is the main regime in the north. Jiangnan Seven Monsters how bad can not be called to take over by beggar's sect and All True Capital as a serious martial arts sect that is not able to agree. At this time, Hong Qi Gong can execute the Drag-Along Right, then even if the Mongols, Jiangnan Seven Monsters and All True Capital how to have opinions, there is no way, or to be sold to the beggar's sect.
2. Co-Sale
Another right corresponding to the Drag-Along Right is the Co-Sale Right. The right of Co-Sale is usually linked to the Right of First Refusal, the following is a common example sentence:
Right of First Refusal and Co-Sale Right: Each Major Investor shall have the right to purchase on a pro rata basis in proposed transfers of any stock held by Each Major Investor shall have the right to purchase on a pro rata basis in proposed transfers of any stock held by the Founders, and shall have the right to participate on a pro rata basis in transfers of any stock held by the Founders.
What does this mean?
a.The Right of First Refusal often occurs when the company is doing well, but the founders don't want to do it anymore. A thought suddenly comes to Guo Jing and Huang Rong one day that this business is so tired even you can take so few stinking money from investors , you have to bet your life on and you do not know if you can live to that day when the company is going to listed in "Huashan Daq". So it is better to go to the island for living a romantic life. Then Guo Jing wants to sell the founder's shares directly and think about who will sell it to. Guo Jing does not know anyone, and it may be better to sell to Anda Torrey brothers. That several investors are obviously reluctant when they develop the company with so much effort and how can it be sold to the Mongolian. This time Jiangnan Seven Monsters, All True Capital and Beggar Capital can execute the Right of First Refusal. That is, Before Guo Jing sell the company to people outside the company, he have to ask if the investors are willing to buy or not. If the Jiangnan Seven Monsters, All True Capital and Beggar Capital all want to acuqire the stocks of the founders by themselves, then they have to purchase on a pro rata basis in proposed transfers of any stock held by the Founders. Note that there is a point here, the price of shareholders who are executing the Right of First Refusal needs to be equivalent to the price which founders sell shares to the public at the begining. That is, when the price of Guo Jing selling the shares to Anda Torrey brothers is 10 yuan per share, then Guo Jing can not sell the shares to investors who later execute the Right of First (Refusal at 15 yuan per share, which means that the conditions must be consistent.
b. Co-Sale often happens when the company's development has been very bad. Guo Jing and Huang Rong want to sell their shares to the Anda Torrey brothers, then at this time Jiangnan Seven Monsters, All True Capital and Beggar Capital also want to sell their shares. At this time, these investors can discuss with Guo Jing that the founders are gone, then we,a bunch of old men, in this company can not do anything. Guo Jing wants to sell to the Mongolians, then we also sell to the Mongolians. But Genghis Khan says, Guo Jing grew up in the desert, and he is our Mongolia's son in law so he only wants Guo Jing's stocks not the stocks of other investors. But this time Jiangnan Seven Monsters, All True Capital and Beggar Capital can execute the Right of Co-Sale, forced Mongolians to acquire their shares together.
