Investment Agreement

What is an investment agreement?

Investment agreement (German: Investitionsvertrag) is the umbrella term in common use in Germany for the contract package by which a funding round is implemented at a company. The package generally includes the participation agreement, the shareholders' agreement, the resolution on the capital increase with the investors' declarations of subscription and the amended articles of association.

The term does not denote a statutory type of contract but originates in practice. The parties are the company, its existing shareholders and the new investors. Where only a single private investor such as a business angel participates, the package is leaner, but the formal requirements remain the same. In colloquial usage, loans or silent partnerships from private backers are also called an investment agreement; they do not, however, confer shares. The package implements the key terms of the term sheet, the previously agreed and largely non-binding outline of terms, in binding form. This takes place after completion of due diligence, the investors' review of the company. What is signed is therefore not a single contract but a bundle of deeds and annexes that refer to one another.

Components of an investment agreement

• Participation agreement: governs the investors' entry, that is, the investment amount, the number and nominal value of the new shares, warranties, liability and completion. This includes the additional payment into the capital reserve, the part of the investment amount that exceeds the nominal value.
• Shareholders' agreement: governs the relationship of the shareholders among themselves for the period after the round. This includes consent requirements, pre-emption and tag-along rights, the liquidation preference (the investors' priority in the proceeds of a sale), anti-dilution protection (compensation in later rounds at a lower price), vesting and information rights.
• Capital increase resolution and subscription declarations: the shareholders' resolution on the increase of the share capital and the declarations by which the investors take over the new shares.
• Restated articles of association: where provisions are to have effect at the level of the company, that is, for every future shareholder, for example restrictions on the transfer of shares (transfer only with consent), an advisory board or special majority requirements.
• Disclosure list (disclosure schedule): the list of matters that are excluded from the warranties.
• Further annexes: rules of procedure for the management, advisory board rules, the founders' employment contracts, an employee participation programme, transfers of intellectual property rights and the new list of shareholders.

Division of tasks between participation agreement, shareholders' agreement and articles of association

The allocation of provisions among the individual documents follows legal differences. The participation agreement concerns a one-off event, the investors' entry, and is largely performed once completion has occurred. Only warranties and liability rules continue to apply until their limitation periods expire. The shareholders' agreement, by contrast, applies on a continuing basis, governs the relationship until the exit and is usually restated in later rounds.

As between the articles of association and the shareholders' agreement, the decisive factor is above all the effect towards third parties. The articles bind every future shareholder automatically but can be inspected by anyone in the commercial register. The shareholders' agreement remains confidential but binds only its parties. Economically sensitive provisions such as the liquidation preference and anti-dilution protection are therefore usually found in the shareholders' agreement. It also obliges the shareholders to transfer shares only to acquirers who accede to the agreement.

Form, notarisation and commercial register

Several components are subject to formal requirements. Amendments to the articles of association, and therefore also the capital increase resolution, require notarisation and a majority of three quarters of the votes cast (Section 53(2) of the German Limited Liability Companies Act, GmbHG). The subscription of a new share requires a declaration by the subscriber that is notarially recorded or certified (Section 55(1) GmbHG). If the shareholders' agreement contains obligations to transfer shares, for example a duty to join in a sale (drag-along) or retransfers on the departure of a founder, it must be notarised under Section 15(4) GmbHG.

The formal requirement covers all arrangements that, according to the intention of the parties, form a single transaction together with such a clause. In practice, the contract package is therefore regularly notarised as a whole. The management then files the capital increase for registration in the commercial register; for cash contributions, at least one quarter of the nominal value must have been paid in for each new share. The capital increase takes effect only on registration (Section 54(3) GmbHG), after which the updated list of shareholders is added to the commercial register.

Sequence from term sheet to completion

1. Signing of the term sheet with rules on exclusivity and confidentiality
2. Due diligence by the investors, with the disclosure list being prepared in parallel
3. First draft of the contract package, prepared, depending on the agreement, by the law firm of the lead investor or that of the company
4. Negotiation of the drafts, coordination of the annexes and obtaining of the necessary consents
5. Notarisation (signing)
6. Satisfaction of the conditions to completion (closing conditions) and payment of contributions and additional payments
7. Filing and registration of the capital increase

In practice, there are often 6 to 12 weeks between the term sheet and notarisation. The duration depends on the scope of the review, the number of investors and the need for negotiation.

Key negotiation points

The key terms of the term sheet are often expressed in a single sentence; in the contract package they become provisions running to several pages. The main subjects of negotiation are:

• Warranties and liability: scope of the warranties, liability cap, de minimis amounts, limitation periods and the question whether founders are personally liable or only the company.
• Consent requirements: which management measures investors or an advisory board must approve and by what majority.
• Economic preferential rights: the detailed structuring of the liquidation preference and anti-dilution protection.
• Founder commitment: vesting, leaver rules and non-compete covenants and their coordination with the employment contracts.
• Transfer rules: pre-emption right, tag-along right, drag-along obligation and the thresholds from which they apply.

On liability, a particular feature of the funding round becomes apparent. If the company pays damages to the investor, the payment also affects the investor economically, because the investor holds an interest in the company. Compensation through additional shares that the investor may take over at nominal value is therefore widespread.

Practical example: investment agreement for a Series A round

A software company in the legal form of a GmbH (German limited liability company) completes a Series A round of EUR 6 million. The pre-money valuation, that is, the valuation before the inflow of the new capital, is EUR 18 million. The share capital is EUR 30,000, divided into 30,000 shares of EUR 1 each. The key terms of the term sheet are distributed across the package as follows:

• Price per share: EUR 18 million divided by 30,000 shares = EUR 600
• New shares: EUR 6 million divided by EUR 600 = 10,000 shares; the investors then hold 10,000 of 40,000 shares, that is, 25%
• Capital increase resolution and subscription declarations: increase of the share capital by EUR 10,000 to EUR 40,000
• Participation agreement: additional payment into the capital reserve of EUR 6,000,000 minus EUR 10,000 = EUR 5,990,000, plus warranties and conditions to completion
• Shareholders' agreement: liquidation preference equal to one times the investment amount, without further participation in the remaining proceeds, anti-dilution protection, consent requirements, founder vesting
• Articles of association: restriction on the transfer of shares and establishment of an advisory board

Every figure from the term sheet thus appears at exactly one place in the package. Before notarisation, it is checked whether the references correspond to one another and whether the majority requirements in the articles of association and the shareholders' agreement are consistent.

Distinction: investment agreement, term sheet and company purchase agreement

• Term sheet: the largely non-binding outline of terms that precedes the contract package.
• Company purchase agreement: governs the acquisition of existing shares against a purchase price that flows to the sellers. In the case of the investment agreement, by contrast, the capital flows into the company.
• Secondary sale: the sale of existing shares to investors, often notarised at the same notary appointment as the round. The purchase price goes to the sellers, not to the company.

Common mistakes

• Reading only the main contract. The shareholders' agreement determines the cooperation of the coming years and deserves at least as much attention as the participation agreement.
• Disclosure list prepared under time pressure. What is missing there remains an unqualified warranty. The list is prepared in parallel with due diligence, not on the eve of notarisation.
• Contradictions between the documents. Differing majorities or consent rights in the articles of association and the shareholders' agreement lead to disputes over interpretation as soon as a decision is due.
• Formal requirement underestimated. A side agreement on share transfers that has not been notarised may be void for lack of form and may call into question the validity of further parts of the package.
• Annexes treated as an afterthought. Rules of procedure, employment contracts and the participation programme are part of the contract and shape the day-to-day work of the management.
• Scattered deadlines overlooked. Warranty, completion and payment deadlines appear in different places in the package and belong in a joint overview.

Frequently asked questions

Is an investment agreement the same as a participation agreement?

Not quite. In the narrower sense, the participation agreement is a component of the investment agreement, namely the contract on the investors' entry. In common usage the two terms are partly used interchangeably; what matters is which documents the specific package contains.

Must the entire contract package be notarised?

In practice usually yes. Amendments to the articles of association and arrangements on the transfer of shares must be notarised. Since these generally form a single transaction with the remaining provisions, the package is notarised as a whole. Which parts require a particular form in an individual case is assessed by the notary and the law firm on the basis of the specific provisions.

Can provisions be amended after notarisation?

Yes, with the consents that the agreement itself provides for, and for parts subject to formal requirements, again before a notary. Shareholders' agreements often require a qualified majority of the investors or the consent of all parties for amendments.

Is there a template for an investment agreement?

Yes, as a starting point. Law firms and industry associations publish model contracts for investment rounds, and many lead investors work with their own standard drafts. A model does not replace adaptation to the articles of association, existing shareholders' agreements and the term sheet, however. Rights of earlier investors must be expressly continued or replaced.

When does the capital flow?

After notarisation, once the agreed conditions to completion have been met. It is usual for the nominal value of the new shares to be paid in first so that the capital increase can be filed. The additional payment into the capital reserve follows, depending on the contract, at the same time, after registration or in tranches.

The Roemer Capital view

The contract package is drafted and negotiated by the law firms of the parties. We coordinate the process, work through the economic provisions, such as the liquidation preference, anti-dilution protection and participation programme, and compare every draft version with the term sheet. Deviations that creep into late drafts are thus noticed before they are notarised.

For the negotiation of the package, we follow a fixed order: the fee agreement on the success fee is signed before the investment agreement is signed. During the discussions on warranties and consent rights, only what has to be settled between the company and the investors is therefore still open.