2022 CASE BLOCK 1 Introduction to Business Law NIKOLE VALDEZ GUAMÁN CLAUDIA LARA ALONSO MARIA JOSÉ BRIZ SANTAELLA RAFAEL MADORRAN CALVO CHARGING, SL is a Spain-based limited liability company whose main activities are the design and manufacture of all kinds of USB chargers for premium devices (smartphones, laptops, tablets, smart devices, etc). The very competitive advantage of its products is the technology applied to the chargers that enables them to complete the charge four times faster than its competitors. The company was incorporated in Madrid on 28th January 2018 with an initial capital of 50.000€ The founding partners are: • Ana María Soto • Carlos García • Payming, SL The capital is divided in 500 stakes of 100€ each (nominal value). According to the capital contributions, partners’ participation in the company is divided as follows: Ana María: 10.000€ 100 stakes 20% Carlos: 8.000€ + laptop 100 stakes 20% Payming: 20.000€ + server 300 stakes 60% Could Carlos contribute the laptop and technological knowledge to the disposition to the company as equity contribution -instead of providing the 8,000 euros? Firstly, both SA shareholders and SL partners must contribute with a minimum amount of capital to the company’s equity. Originally, these investments can be either related to pecuniary nature (cash), of property, goods, equipment or in kind. In this case, the laptop could be contributed to the company as an asset, specifically as equipment, however, in SL, there is no need to do an expert report to confirm the actual value of this asset. Therefore, the responsibility of defining a value lies with the investment partner (Carlos) and is agreed by the remaining ones. Nevertheless, the provision of knowledge or professional services are not defined or allowed as equity contribution for the company as they are considered ancillary services. In other words, they are one the obligations to be fulfilled by the SL, among contributing the necessary capital, at least 3,000 euros. Could Ana María - driving force behind the idea of setting up a company- receive 125 shares instead of the 100 mentioned? In relation to the transfer condition, SL establishes that stakes are not generally free or transferable. In fact, the bylaw forbids members from transferring shares unless it is to leave the company, but this restriction becomes unconditional in the first 5 years. Hence, Ana Maria could not receive 125 instead of 100 shares unless it is a voluntary inter vivos transaction among partners or unless she contributes more to the company. 1 According to the company's bylaws, the company is managed and represented by two directors acting on a joint basis (Ana María and Carlos). In the very first stage, and due to the weak financial situation experienced by the company, it is urgent to get a bank loan and Carlos decides to sign a financial agreement in his name and on behalf of the company and asks PAYMING to sign as 1 Rodrígez, T. (2010). INTRODUCTION TO SPANISH PRIVATE LAW FACING THE SOCIAL AND ECONOMIC CHALLENGES. University of Texas at Austin Studies in Foreign and Transnational Law. 1 well as major shareholder. Is the agreement valid and enforceable? If not, who would be entitled to challenge that agreement? When it is decided to issue new shares to a designated person or company, for instance, giving shares to a new shareholder/partner in exchange for capital (case of PAYMING), it must be previously discussed and carefully considered in the bylaws or shareholders' agreement. 2 We can consider PAYMING as a main investor, as it is the major shareholder (60% stakes) and the one who would lose much more if any of the partners want to leave the arrangement. Therefore, PAYMING could challenge the decision if it has been abusively imposed by the other partners, in noncompliance with the bylaws. After one year, business is being successful. The activity of CHARGING SL is increasing at a significant rate and three contracts with popular distributors (like Amazon or Best Buy) have been concluded in the last five days. Despite such a promising outlook, expenses are really high at the ending of the start-up stage and most part of the contract is subjected to installments plans. Therefore, the company has to urgently improve its financial situation. Partners have estimated that financial resources needed to face the next stage in their business amount to 150.000 €. In a quite strained meeting of all partners, several options were considered: A. Increase the company capital in 150.000 € by issuing new stakes that the current partners will have to buy. Briefly explain the highlights of this corporate transaction There are many ways that CHARGING SL could have chosen to increase the company's capital: increasing the nominal value of existing shares, reinvesting dividends back to the business or issuing new shares to the market. In this particular case they have chosen the third option. When choosing this option of increasing the company’s capital, old partners usually have the right of buying first. Assuming this is the case in CHARGING SL, the current partners of the company will have to buy these new shares (using their right to buy first) to maintain their current power (% of owner's equity) within the company. For the old partners, the emission of new shares is not usually an exciting option because it means that they will have to put more money individually into the business to have exactly the same % of the company as before. Thus, this may seem contrary to the old partners interests, it should also be viewed as an interesting investment in the company’s future and the potential of the financial plan. What happens if one of the partners does not have sufficient financial availability for the expected contribution? 2 Sociedad anónima versus sociedad limitada (s.f). Tax partners.https://www.accountinginspain.com/sociedad-anonima-versus-sociedadlimitada/ 2 When one partner doesn’t have sufficient financial availability for the expected contribution, he has several options: 1. Sell his rights of buying first, and therefore, losing some of his individual influence on the company → [loose a great % on owner’s equity] 2. Try to acquire as many shares as possible and then sell his rights of buying first when he can’t afford buying more→ [losing LESS % on owner’s equity] 3. Make a White Operation (operación blanca). Which basically consists of a buying of new shares at the new issuing price, selling the preferent subscription rights so that the old actionist doesn’t have to pay any money from his pocket → [losing some % on owner’s equity] Can the other partners acquire then his/her proportion of the new shares instead? Of course. This way, the other partners will have a greater influence on the company's decisions since they invested more money in it. B. Accept Tim Shaffer’s investment in the company, making him a serious offer. Are they losing control of the company? Yes. In this case, Tim Shaffer acts as a business angel, which may be extremely useful for CHARGING SL as it is still in its early stages of development. However, having a business angel also means giving up some equity, usually between 10-20% (but it could be more). Thus, the investor is now entitled to participate in business decision- making, which may cause conflicts of interests between the founders (Ana María Soto, Carlos García and Payming, SL) and Tim Shaffer. How can the founding partners prevent the Business Angel from taking total control over the company? By establishing clear bylaw’s provisions and/or investment agreements which will set boundaries. An offer was sent to Tim Shafer (business angel). The business angel accepted the offer, but his final decision was subject to the following requirements: 1. After a due diligence of the company, the business angel could be interested in investing 450.000€. The expected time limit of his investment is 3 years with a year rate of return of 15%. In the second year, the founding partners will be entitled to buy a 50% of the business angel’s equity capital. The sale price will be increased by 15% over the contribution. What’s a Due diligence? Due diligence is the study of a company’s financial records before entering into a proposed transaction with another party, aiming to avoid risky investments.3 Is the year rate of return 15% acceptable for the founding partners? Is it legal? 3 Chen, J.What Is Due Diligence? Investopedia. Retrieved Oct 17, 2022, from https://www.investopedia.com/terms/d/duediligence.asp 3 It all depends on the decisions initially taken in the Shareholder’s Meeting for the investment agreement, based on a majority basis. If most partners agree to accept the 450.000€ investment in exchange of the yearly rate of return of 15%, it is completely legal and should be accomplished if possible (if there are benefits from the activity). 2. Any decision involving the entry in the future of other investors in the company requires the favourable vote of the business angel. Is this condition acceptable for the partners? Why? At which point should the partners compromise? Again, the business angel has voting rights (among others) to participate in the decision of accepting a new investor or not. However, if the majority of votes support accepting the new investor and only the business angel is against, the final decision will be to welcome the new investor. This is because decisions are taken based on a majority basis. On the other hand, if the new investor would want to buy only from the majority partner (who may be the business angel) or if the majority partner hides this offer to the minority partners so he can sell all his stakes and benefit just himself, minority partners can appeal to the Tag-along clause (stated in advance in the bylaws or the investments agreement) which states the following: - If the majority partner has not hidden the offer or the new investor is willing to buy stakes from any partner, all partners (majors and minors), will sell the proportion of their stakes in relation to the percentage of the firm that the new investor is interested in buying. - If the majority partner has hidden the offer or the new investor refuses to buy from minority partners, minority partners can call the Put Option, by which they will sell their proportion of stakes to the majority partner. This way, they all receive benefits from the offer accordingly. 3. The business angel will be entitled to appoint all directors of the company. Is this condition acceptable? At which point should the partners compromise? Business angel’s equity (and control over the company) corresponds to the amount invested. Thus, only if the investment supposes the major percentage of stakes among all the partners, the business angel will have the ultimate decision about who are the directors of the company. Otherwise, a majority basis will be followed. In this case, the business angel holds just a part of the firm’s equity due to the size of his investment (450,000/3 years) so that founder partners should clarify on the legal documents that this type of decisions (choosing the directors) will be a matter of all of them, not just the business angel or the founders. 4. If the business angel receives an offer from a third party to buy the whole company, the current partners will be committed to sell their participation in the company at the price proposed by the buyer and accepted by the business angel. Advise them how to proceed in order to anticipate such risks and prevent them. Draft at least two of the conditions that should be included in the investment agreement to be entered into between the investor (BA) and the entrepreneurs. To avoid any conflict, these two clauses should have been included in advance in the agreement investment: 4 • Drag-along clause: to avoid the situation in which the majority partner can’t accept an offer (for the 100% of the firm) because the minority partners are against it. Thus, minority partners have two alternatives: - Sell to the investor with Partner A - Offer majority partner to buy his stakes in the same conditions as the investor. If minority partners are still against selling, the majority partner can use the call option, which allows him to buy all minority partners’ stakes under certain conditions and so he can sell to the investor. • Tag-along clause: if the investor would want to buy only part of the firm. To avoid that the majority partner sells only his stakes, leaving minority ones without chance to trade, tag-along clauses anticipate these situations and provide a re-balancing solution: each partner will sell only the corresponding percentage of their stakes within the investor’s offer. If the majority partner hides the deal or the investor refuses to acquire from minority partners, minority partners can use the put option: sell their stakes to the majority partner so they ensure an input. The current partners don’t want to offer the business angel a participation in the capital higher than 20%. How can they achieve it without losing the promised funding of 450.000€? Negotiating those terms and leaving a record of them in the bylaw’s provisions (more severe) and/or the investment agreement. If the investor is hard to convince, maybe current partners should give up in other aspects such as offering a higher yearly rate of return or any other feature that may be interesting for the investor and does not suppose a dilution effect. In order to structure the investment, an investment agreement will be signed among all current partners and the business angel. The following two stipulations were included in the investment agreement aiming to regulate some of the previous points. Explain their content; to whom of the current partners try to protect and what risks are they anticipating. [A] Each of the Shareholders hereby grants to the other Shareholders the right (but not the obligation) to join the Selling Shareholder(s) and co-sell (together with the Selling Shareholder(s)) upon the election of the relevant beneficiaries all their Shares to the proposed acquirer for the same consideration per Share and otherwise at the same terms and conditions as applicable to the Selling Shareholder(s) [except for [(i)] any representations, warranties and/or indemnities other than (several and not joint) title warranties solely in respect of the Shares sold by such other Shareholder(s) and (ii) payment of the consideration per Share, which must be in immediately available cash] upon the occurrence of a Tag-Along Event. Stipulation A is intended to protect minority shareholders, in this case, Anna Maria and Carlos, who each hold 20% of the company. This clause foresees the risk that Payming, which owns 60% of the company, can unilaterally benefit from profitable deals with third 5 parties who want to acquire a majority percentage of the company. Payming may be looking to sell only its stakes in the company, leaving minority shareholders vulnerable to new investors holding the majority. Therefore, this clause’s aim is to re-balance this possible situation in favour of the minority shareholders and provide them with a viable exit option in the occurrence of a Tag-along event as described4. Should partners/shareholders be able to join with other partners who intend to sell their shares to a third party? Shareholders should be able to join with other partners who intend to sell their shares to a third party when this transaction implies a partner trying to sell a larger controlling stake and the subsequent constitution of the third party as the new majority shareholder. In the occurrence of this event, minority shareholders would be left captive in the venture with a new and unfamiliar partner. Thats why, in this case, shareholders should have a right to take advantage of the deal with the third party and sell in the same conditions and same proportion. These are the so-called Tag-Along rights. On the other hand, as the third party cannot be forced to buy shares from minority shareholders, they also have a put option which entitles them to sell the proportion of their shares to the majority partner, at the same price as the investor is offering or higher. B] The Relevant Selling Shareholder[s] shall have the right (but not the obligation) to require all other Shareholders to sell, and the other Shareholders hereby irrevocably agree to sell, all (but not less than all) of their Shares then held to the proposed acquirer for the same consideration per Share and otherwise at the same terms and conditions as applicable to the Relevant Selling Shareholder[s] upon the occurrence of a Drag-Along Event. Clause B is intended to protect Payming, the majority partner, upon the need for minority acceptance to pursue its interests. This clause anticipates the risk of Payming being a prisoner to the company’s will and cannot proceed with a beneficial wholesale because of the minority reluctantly. Should majority partners/shareholders be able to force minority partners to join into a sale? Yes, having a drag-along clause that allows majority shareholders to force minority partners to join a sale can be beneficial for both parties and adds solidity to the venture. On one hand, this clause protects the company from not being able to sell just because a small minority is trying to block the transaction, which leaves the company’s majority partners’ interests totally vulnerable to minority shareholders. On the other hand, it is true that this can lead to minority shareholders being forced to sell even though they might have a solid interest in not doing so. However, looking at it from another perspective, this also means that, if the company is acquired by a third party, the minority partner cannot be excluded from the deal, and it will also be included in its eventual reported earnings. 4 Navigating a Shareholders Agreement: Drag Along and Tag Along Rights. (s. f.). HFW. Retrieved 15 october 2022, from https://www.hfw.com/Navigating-a-Shareholders-AgreementDrag-Along-and-Tag-Along-Rights-Apr-19 6
