Co-Sale Agreement

What is a co-sale agreement?

Co-sale agreement (contract on rights of first refusal and co-sale) refers in the US market to a standalone contract between the company, the founders and the investors that governs sales of shares by the founders to third parties. Besides the founders, other key shareholders are often covered. The contract combines two rights: the right of first refusal (ROFR), to buy the shares oneself, and the co-sale right, to join in the sale.

In US financing rounds the contract is part of the standard package, usually under the name “Right of First Refusal and Co-Sale Agreement”. The model documents of the NVCA (National Venture Capital Association), the US association of venture capital investors, are often used as a template. Alongside it come the purchase agreement for the new shares (Stock Purchase Agreement), a contract on investor rights (Investors' Rights Agreement) and a voting rights agreement (Voting Agreement). German financing rounds have no separate document of this kind. Rights of first refusal and co-sale are set out here in the shareholders' agreement, a contract between all shareholders alongside the articles of association, which is concluded together with the participation agreement. The term appears in German transactions mainly when US investors are involved or US models serve as a template.

Structure of the co-sale agreement under the US model

The co-sale agreement obliges the key shareholders (key holders) to give advance notice of a planned sale to a third party. A two-stage procedure then follows:

1. Right of first refusal: First, the company itself can buy the shares on the notified terms. If it does not use the right, or not in full, the investors can acquire the remaining shares in proportion to their holdings.
2. Co-sale: For shares that were not acquired under the right of first refusal, the investors can require the third party also to take over part of their shares on the same terms. The seller's quantity is reduced accordingly.

Transfers in the context of estate planning and to affiliated companies are generally excluded, in some cases also smaller transfers up to an agreed limit. The rights often belong only to major investors (Major Investors) above an agreed size of shareholding. Under the US models, the contract usually ends with the IPO or with the sale of the company.

Implementation in the German shareholders' agreement

When transferring this into German documentation, three points have to be observed.

Right of first refusal of the shareholders instead of the company

A GmbH (German limited liability company) can acquire its own shares only to a limited extent. Under Section 33 of the German Limited Liability Companies Act (GmbHG), the contributions on the shares must have been paid in full. In addition, the company must be able to form a reserve equal to the purchase price without touching the share capital or restricted reserves; payment is therefore made only from free assets. Growth companies with start-up losses often do not meet this, because the losses have consumed the equity above the share capital. German agreements therefore generally grant the right of first refusal to the fellow shareholders, not to the company.

Notarisation, articles of association and transfer restrictions

A right of first refusal obliges the seller to assign shares when it is exercised. The agreement must therefore be notarised under Section 15(4) GmbHG. The rights are secured through a transfer restriction (Vinkulierung) in the articles of association, under which transfers require consent. Because the articles of association are open to inspection by anyone in the commercial register, the details are usually set out only in the confidential shareholders' agreement. Articles and agreement must be aligned with each other so that no divergent deadlines or procedures arise.

Embedding in the rest of the contract documentation

What is spread across several contracts in the US package is bundled by the German shareholders' agreement. Besides rights of first refusal and co-sale, it contains the drag-along obligation, pre-emptive rights on future capital increases, information rights and voting agreements, that is, arrangements on how the shareholders vote on certain resolutions. The clauses on share sales must therefore be aligned with the drag-along obligation. If it is exercised, rights of first refusal and co-sale must not hold up the sale.

Worked example: right of first refusal and co-sale in a share sale

In a GmbH with 100,000 shares, the founder holds 50,000, investor A 30,000 and investor B 20,000. The founder wants to sell 10,000 shares at EUR 200 per share to a business angel, EUR 2 million in total. The shareholders' agreement provides first for a right of first refusal of the investors and then for a proportionate co-sale right.

• Stage 1, right of first refusal: A and B can take over the 10,000 shares in the ratio 30,000 to 20,000. A would receive 6,000 shares for EUR 1.2 million, B 4,000 shares for EUR 0.8 million, and the business angel would go away empty-handed.
• Both waive the right of first refusal. Stage 2, co-sale: A exercises its co-sale right, B does not.
• Split of the 10,000 shares between the founder and A in the ratio 50,000 to 30,000: founder 10,000 × 50/80 = 6,250 shares, A 10,000 × 30/80 = 3,750 shares.
• Proceeds: founder 6,250 × EUR 200 = EUR 1.25 million, A 3,750 × EUR 200 = EUR 0.75 million, EUR 2 million in total.

The business angel receives the desired stake, but partly from a different seller. The founder realises EUR 0.75 million less than planned. If both periods run one after the other, for example three weeks each, at least six weeks pass before completion, which must be planned for in the buyer's timetable.

Distinction: co-sale agreement, tag-along right and right of pre-emption

• Tag-along right: the individual co-sale right. The co-sale agreement is the contract document that combines this right with the right of first refusal into a single procedure.
• Statutory right of pre-emption under Sections 463 et seq. of the German Civil Code (BGB): the right, regulated by statute, to buy on the terms that the seller has agreed with a third party. It presupposes a purchase contract already concluded with the third party. Rights of first refusal under company law usually apply earlier, as soon as the sale is notified, and provide for several beneficiaries, deadlines and price rules.
• Voting agreement: the US voting rights agreement from the same contract package. In Germany, it corresponds to the voting commitment in the shareholders' agreement or a pooling agreement.
• Registration rights: rights to resale after an IPO, which in the US package are set out in the contract on investor rights and not in the co-sale agreement.

Common mistakes

• US model adopted without adaptation. A right of first refusal of the company often fails for a GmbH because of the limits of Section 33 GmbHG.
• Missing notarisation. If the agreement is signed as an ordinary contract, the obligations to assign are not validly established.
• Conflict between articles of association and agreement. Different deadlines or beneficiaries in the two documents lead to disputes in the event of a sale about the correct procedure.
• No waiver by majority resolution. If every investor has to waive individually, a single beneficiary can hold up a small sale for a long time.
• Deadlines not aligned. If notification, first-refusal and co-sale periods add up without an upper limit, a third party easily loses interest.

Frequently asked questions

Does a German GmbH need a co-sale agreement?

No. The rights are set out in the notarised shareholders' agreement and secured through the articles of association. A separate document on the US model brings no advantage and increases the risk of contradictory provisions.

What is the difference between right of first refusal and co-sale right?

With the right of first refusal, the beneficiaries buy the offered shares themselves, and the third party does not get them to that extent. With the co-sale right, they sell their own shares to the third party alongside the seller. In the co-sale agreement, the right of first refusal applies first and, for the shares not acquired, the co-sale right applies after that.

Who is party to a co-sale agreement?

Under the US models, the company, the key shareholders whose sales are covered, and the entitled investors. In the German shareholders' agreement, all shareholders are generally parties, often the company too.

Can an investor waive its rights?

Yes, for an individual sale or generally. A rule under which a majority of investors can declare the waiver for all beneficiaries is common. This prevents a small share sale from depending on the consent of every single investor.

Does a co-sale agreement continue to apply after an IPO?

As a rule, no. The US models let the contract end with the IPO. German shareholders' agreements often provide for the same, because the shares of a listed company are meant to be freely tradable.

The Roemer Capital view

If international investors bring US model documents into a round, Roemer Capital assesses for the client, from an economic point of view, which provision belongs where in the German documentation. This includes the consequences it has for later share sales. The legal transfer into the shareholders' agreement and articles of association is handled by the company's law firm.

For share sales outside an exit, Roemer Capital checks in advance which investors may exercise first refusal or co-sale and, where appropriate, asks early for waiver declarations. This keeps deadlines and shareholdings plannable even when several investors have rights.