As soon as there's a chance to make a ton of money, they're there. Who? Investors. Investment funds. VCs. Is that a problem in itself? Not really. Companies need funds to grow, and investors need entrepreneurs to make their money grow. In principle, it's a fair exchange. Except that sometimes, things go wrong.

Let's take the example of Jean and his team. Entrepreneurs in a highly profitable sector (confidential, sorry!), they have become the ideal target for investors.

As usual, the founders want as much money as possible with as little dilution as possible. Their objectives are clear: to develop the company internationally and, above all, to remain the majority shareholders.

So, when a fund approaches them, their mantra quickly becomes "stay in control." That's their fear: becoming a minority shareholder in their own company. We explain to them that owning more than 50% of the capital means nothing if, in reality, they lose political and financial control. But their excessive ambition pushes them to accept a deal against their board's advice:

• Investor acquires 30% stake in the capital for €15 million
• Transformation of the company into a simplified joint stock company (SAS)
• Issuance of preferred shares with special rights for the benefit of the investor (the "ADPs")

What are "ADPs"?

*Get out your keyboards*

In a simplified joint-stock company (SAS), the share capital is divided into shares. So far, so good.

These shares are, in principle, common shares—basically standard shares. Each holder of a common share has traditional rights such as:

– Voting rights at meetings

– Right to receive dividends based on profits and in proportion to your shareholding (after those with ADPs have been paid)

– In the event of liquidation, partners will be reimbursed for their initial investment (after ADP holders 😉).

Simple illustration: if you own 30% of the capital, in most cases you are entitled to 30% of the distributable profits, the liquidation surplus, the sale price of the company, etc.

ADPs are shares that offer advantages over ordinary shares (PS: they can also offer "negative advantages" (i.e., disadvantages), but we're not here to go into the details of legal instruments—our goal is for you to understand the principles).

For example, ADP holders may have double voting rights; receive priority dividends, priority in the event of liquidation of the company or exit, etc.

One can imagine a huge number of mechanisms with ADPs.  

In summary, ADPs offer much greater security and specific financial advantages. This is useful when you want to eliminate entrepreneurial risk.

Yes, with ADPs, you can arrange to never lose.

ADPs can therefore become super-privileged shares (a bit like the super-privilege of the tax authorities, which help themselves to everyone's pockets before anyone else).

*Put away the keyboards*

 

The LAW* seems reassuring for Jean & co with terms such as:

"Our valuation is based on the strengths and growth potential of [your company], your desire to remain the majority shareholder in the company, the long-term nature of the business relationships you have built, and an ambitious business plan..."

Except that...

… the co-founders hold 70% of the share capital (in common shares) versus 30% for the investor (in ADP),

ADPs grant investors significant rights, allowing them to capture most of the value created. In short, Jean and his friends work to ensure that nearly 90% of profits go to investors, through dividends, reserves, bonuses, and other distributions.

In their case, this is the effect of the ADPs that were issued by the company to the investor in return for their investment.

Today, Jean and his friends are bummed out as they stare at their Excel spreadsheet, which illustrates the harsh reality:

Let's take the example of a distributed profit of €100:

· The investor receives three times more: €90 instead of €30 (since they only hold 30% of the shares and, unless otherwise specified, payments are made based on the percentage of shares held), representing an increase of nearly 200%.

· Founders receive 600 times less: €10 instead of €70, a reduction of more than 85%.

And that makes us mad too.

And you know what? These unbalanced practices are most certainly contrary to corporate law.

Remember this:corporate law prohibits a partner from taking the lion's share.In legal terms, this is called the prohibition on benefiting from leonine clauses (lion/leonine: easy to remember).

We wonder how long entrepreneurs will accept such practices when they potentially have the law on their side and could potentially blow up completely unbalanced deals or at least shake up those who think they can do whatever they want.

So, when you negotiate your fundraising, stand up for yourself.

Jean & co decided to defend themselves—better late than never.

To be continued.

*LOI stands for "Letter of Intent." It is a non-binding document that expresses the parties' intention to enter into a specific agreement, setting out the main terms and conditions of the proposed investment.