Venture capital in future foods businesses: the art of balancing investor protections in shareholder agreements

Venture capital investors invariably require contractual protections to safeguard their investment. Generally, it follows that a greater level of investment (whether by amount or proportion of a round) necessitates greater protection. All rights, however, must to be proportionate and balanced as between competing investors, the founders and what the company needs to be able to operate successfully and grow.

Key rights in a shareholders' agreement that businesses should focus on to reach the right balance include board representation, reserved consent matters of investors, information rights and founder restrictive covenants.

Board representation

Major investors will often seek board representation so that there is somebody on the board who is able to have regard to the investor's interests and to actively participate in the company's day-to-day decision-making.

This may manifest in the right to appoint one or more investor directors to the board (depending on the company's board size). In this case, only the appointing investor will typically be able to terminate and/or replace the appointed individual; though, this right should at all times be subject to the investor continuing to constitute a "major investor" in the company (that is, maintaining an agreed percentage shareholding in the company (for example, 10%)).

By contrast, certain minority investors (such as a 2 – 5% investor shareholder) may seek a non-voting observer right to allow one of their representatives to attend and speak at board meetings, but who cannot vote on any board decisions.

Investor board representation can provide invaluable expertise which can aid the company's development, but it is important to maintain a balance of views between the competing interests of the company, the founders and investors. To that end, certain companies may benefit from the appointment of an independent industry expert who can offer unbiased perspectives and support. Depending on the development stage of a future foods business, this may include an individual who has successfully launched or scaled similar businesses, experts in food technology and innovation, or professionals with experience in consumer trends and market dynamics in the food sector. Individuals with expertise in sustainability, supply chains, nutrition or regulatory affairs may also prove useful.

Thought should also be given to the total number of directors, as well as the ratio between the founder, investor and independent director groups. A saturated or heavily-weighted board (in favour of either the founders or the investors) may lead to inefficient decision-making.

Reserved consent matters

Major investors will also require contractual rights of consent which afford them, and/or their board representative(s), the ability to veto certain proposals or decisions that could materially change or affect the company's business. This allows them oversight on key matters that are important to protecting, or that could adversely affect, their investment – such as those relating to the company's operations, shareholding, product development, intellectual property and/or market strategies.

The British Private Equity & Venture Capital Association (BVCA) provides guidelines for investor consent rights at a shareholder and investor director level. It has also published template investment documentation, which includes a list of UK market-standard examples. In respect of shareholder consent matters, these include: (i) changes to the company's articles of association or share capital; (ii) insolvency; (iii) dividend payments; and (iv) other major transactions, such as acquisitions and disposals of material assets. Board representative consent matters may include: (i) adopting or changing a business plan and budget forecasts; (ii) employing, or varying the employment terms of, high-earning individuals; and (iii) commencing litigation.

When implemented correctly and proportionately, the consent process can promote transparency, accountability and collaboration between investors and future foods companies. However, if the consent process becomes too onerous, it can quickly become obstructive and frustrate innovation and development. This is likely to be particularly problematic in a rapidly-growing and competitive sector, such as future foods.

Information rights

Major investors are also likely to require access to timely and accurate information about the company's performance and financials. Common examples include annual accounts, monthly management accounts, quarterly share capital statements, annual business plans and budgets and any other information which the they may reasonably request from time to time.

Information rights allow investors to monitor their investment and make informed decisions. Providing regular updates and adhering to transparent reporting mechanisms also fosters trust and increased collaboration between investors and companies.

Before granting information rights, the company should consider the time and cost of preparing the information, the frequency of the request and whether any safety measures are required and appropriate to safeguard sensitive and confidential information (such as non-disclosure agreements and data protection measures). In any case, the disclosed information should be limited to that which is necessary to monitor the investor's interests.

Restrictive covenants

In UK future foods venture capital transactions, it is standard market practice that founders enter into restrictive covenants in favour of the company and its investors.

Restrictive covenants can take the form of non-compete and non-solicitation provisions. These prevent founders from directly or indirectly competing and/or poaching key employees, clients and suppliers during their employment with the company and, often, for a limited period after they leave. Post-employment restrictive covenants are usually effective for a period between 6-24 months, and would apply in addition to any restrictive covenants contained in the leaver's employment or service agreement.

Establishing a fair balance between founder and company/investor interests will promote a mutually beneficial relationship. Provisions that are too restrictive may affect the founders' sense of trust, motivation and commitment to the company's success. If too permissive, they may expose the company to undue risk from competitors.

This line must be carefully trod as competition authorities around the globe are paying increasing attention to restrictive covenants which, in their view, may have an impact on an individual's future employment prospects. The presence of these clauses has led to substantial fines in certain jurisdictions. Most recently, the US Federal Trade Commission has voted to ban non-compete agreements that seek to prevent employees taking up new employment opportunities.

To best ensure enforceability from a legal perspective, the restrictions should only limit the conduct of the founders as far as is necessary to protect the legitimate interests of the company (and investment).

Osborne Clarke comment

Balancing investor protections in future foods businesses is crucial for fostering a healthy investment ecosystem. Striking the right balance allows investors to protect their interests while enabling businesses to grow, innovate and create social and economic value. Ultimately, a collaborative and mutually beneficial relationship between investors, founders and companies is key to the success of venture capital transactions.

In the second Insight in our mini-series on balancing investor protections, we will review the key provisions of the company's articles of association, including drag and tag along rights; anti-dilution protections; leaver terms; and liquidation preferences.

Osborne Clarke has a market leading venture and growth capital practice across Europe, supporting investors, founders and companies in the future foods sector. If you have queries on any of the issues covered in this Insight, please connect with one of our experts.