‘The VC Series’ is a series of articles aimed at founders who are thinking of raising funds from VCs. Further information about The VC Series can be found here.
This article looks at some of the key terms that VCs would expect to see included regarding the transfer of shares – specifically, the right of first refusal, co-sale and tag along rights. The next article will then explore drag along rights.
This article focuses on the different provisions that relate to the transfer of existing shares by a shareholder or a group of shareholders.
This is distinct to the issue of new shares by the company. This article will not cover the issue of new shares in any detail, other than to say that typically (i) some form of shareholder authority will typically be required before the directors are authorised to issue shares, (ii) in addition, it is likely to require the consent of the VC, and (iii) unless waived by the shareholders (normally be a special resolution), any issue of new shares must be offered to all shareholders in proportion to their existing shareholdings.
The investment documentation (typically the articles of association) will provide that, as with an issue of new shares, if a shareholder wishes to transfer some or all of their shares, they must first offer them to the other shareholders (or sometimes a particular group of shareholders) in proportion to their shareholdings.
The exceptions that you might expect to find are:
Whilst these are provisions that need to be negotiated and agreed in a proper way, it is also important that they are put in context.
The reality is that there isn’t often a market for shares in scale-up companies, particularly given that S/EIS relief is only available on the issue of new shares, not the acquisition of existing shares. The likelihood therefore is that, even if the documents provide for a certain amount of flexibility, a founder might not be in a position to sell any shares until an exit (or to an investor on a future funding round if that can be negotiated).
Co-sale and tag along rights impose further restrictions on the ability of shareholders to sell their shares. There is a subtle difference between the two terms, explained as follows:
In each case, the right typically only kicks in after the RoFR process has been completed.
The next article in The VC Series explores drag along provisions.
Full details of the VC Series can be found here.
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