What are the Clauses Related to Company Management in Investment Contracts?

Various clauses are stipulated in investment contracts, including those related to the operation of the company. From an investor’s perspective, these operational clauses aim to ensure sound business operations within the company, thereby enhancing the success rate of the investment. They also aim to accurately understand the status of the target company for investment and establish a system for appropriate responses as a fund operator.

Operational clauses in a company contain many important provisions for both venture companies receiving investment and venture capitalists (VCs) making the investment. Therefore, this article will explain the clauses related to company operations in investment contracts.

https://monolith.law/corporate/importance-and-necessity-of-investment-contract[ja]

Provisions Regarding Company Management in Investment Contracts

In investment contracts, the following provisions regarding company management can be considered:

1. Provisions on the obligation to make efforts for listing
2. Provisions on the use of funds
3. Provisions on the dispatch of directors and observers
4. Provisions on pledges
5. Provisions on notification of important matters and prior approval by investors
6. Provisions on post-notification to investors
7. Provisions on dedication to management

Clause on the Obligation to Make Efforts for Listing

Investors such as Venture Capitalists (VCs) need to aim for a return on their investments. Moreover, for VCs who manage funds from other investors, it is necessary to invest in situations where a return is expected.

Therefore, it is conceivable to stipulate clauses regarding when the company aims to go public, and whether the company can operate its business appropriately towards listing. In investment contracts, this is usually stipulated as a clause called the “Obligation to Make Efforts for Listing”. This obligation is often defined as a “duty of effort”.

However, even if it is a “duty of effort”, if the company neglects its efforts towards listing, it will violate the investment contract, so the company should sincerely strive to go public. In some cases, it is clearly stipulated as a contractual obligation, not a duty of effort, and in case of violation, there may be a case where the obligation to purchase shares arises. Therefore, it is necessary to carefully check whether it remains a duty of effort or is clearly stipulated as a contractual obligation.

Also, it is conceivable that VCs and others can earn returns through M&A, so in addition to listing, clauses regarding the timing of Exit including M&A may be stipulated. In that case, the agreement on the timing of Exit and the clause on the duty of effort towards that Exit will be stipulated as the content of the investment contract.

Below is an example of a clause on the obligation to make efforts for listing.

Article ○ (Public Offering)

The Party B shall make maximum efforts to list or over-the-counter register (hereinafter referred to as “public offering”) the Party B’s shares on the public stock market agreed by the Party A in the shortest possible period, and shall take all reasonable measures necessary for the public offering in accordance with the advice of the Party A.

Clause on the Use of Funds

When venture companies and the like raise funds, they do not do so without a purpose. Instead, they raise funds in relation to a specific financial need. Venture capitalists (VCs) and other investors consider the necessity of the investment, the required investment amount, and other factors in relation to the specific financial needs of the venture companies, and then make their investments.

Therefore, a clause on the use of funds may be stipulated in the investment contract. If the use of the funds is somewhat determined but not specifically defined, the clause on the use of funds may be abstractly defined as “general working capital for ○○”.

On the other hand, if the use of the funds is specifically determined down to the details, it may be specifically defined as “introduction of a system for ○○”. It is necessary to thoroughly confirm the clause on the use of funds between the investors such as VCs and the venture companies, and stipulate it in the content of the investment contract.

Provisions Regarding the Dispatch of Directors and Observers

It is conceivable that venture capitalists (VCs) and similar entities may dispatch their own personnel to serve as directors of venture companies and the like, in order to monitor and supervise their decision-making processes and to gain insight into their internal information. They may also consider dispatching them as observers. For more information on provisions regarding the dispatch of directors and observers, please refer to the article below.

https://monolith.law/corporate/clause-dispatching-of-company-executives[ja]

Covenants in Investment Agreements

Covenants are often included in investment agreements. The main purposes of these covenants are to ensure proper corporate management for potential public listings and to secure opportunities for venture capitalists (VCs) and similar investors to gather appropriate information. Specifically, covenants in investment agreements may cover the following areas:

Maintenance of Proper Accounting Books

When a startup aims for a public listing, it is essential that their accounting books are in order. Therefore, a covenant may be included in the agreement, requiring the startup to maintain the propriety of its accounting books.

Maintenance of Proper Transactions Conducted by Officers and Related Parties

In the public listing review process for startups, transactions conducted by related parties are generally subject to disclosure, and their propriety is reviewed. Therefore, a covenant may be included in the agreement, requiring the officers and related parties to maintain the propriety of their transactions.

Responses to Questions from VCs and Other Investors, and Disclosure of Information from Startups to Investors

From an external investor’s perspective, it is not always easy to fully understand the internal affairs of a startup. Therefore, a covenant may be included in the agreement, requiring the startup to respond to any questions from investors. Additionally, a covenant may be included requiring the startup to disclose information to VCs and other investors.

Maintenance of Proper Financial Statements and Tax Returns

When a startup aims for a public listing, it is essential that their financial statements and tax returns are in order. Therefore, a covenant may be included in the agreement, requiring the startup to maintain the propriety of its financial statements and tax returns.

Contents and Submission of Business Plans

Companies operate based on their business plans, so it is crucial that these plans are properly formulated and followed. Therefore, a covenant may be included in the agreement, requiring the startup to ensure the propriety of its business plans and to submit these plans to VCs and other investors.

No Association with Anti-Social Forces

Any association with anti-social forces can not only prevent a startup from going public, but also pose reputational risks and potentially involve the startup in illegal activities. Therefore, a covenant may be included in the agreement, requiring the startup to ensure that it has no association with anti-social forces.

Compliance with Laws, Articles of Incorporation, and Internal Rules

If a startup violates compliance, VCs and other investors can claim damages, even if there is no provision in the investment agreement. However, to make a claim for share repurchase or similar actions due to a breach of contract, it is necessary to stipulate this in the investment agreement. Therefore, even though compliance is a given even without an investment agreement, it is necessary to include a covenant in the agreement, requiring the startup to comply with laws, articles of incorporation, and internal rules.

Provisions Regarding Notification of Important Matters and Prior Approval by Investors

How significant matters are handled in the operation of a company is of great concern to investors such as venture capitalists (VCs). For instance, it is conceivable that VCs could suffer unexpected losses if venture companies undertake significant actions such as changes to the articles of incorporation, organizational restructuring, and issuance of new shares. Therefore, provisions regarding notification of important matters and prior approval by investors may be stipulated in the investment contract. From the perspective of venture companies, this clause restricts their managerial freedom. Therefore, it is necessary to thoroughly discuss with investors what matters will be subject to this clause, to whom notifications should be sent, and who should be granted the right to prior approval.

Clause on Post-Notification to Investors

There may be provisions stipulating that venture companies and the like should provide post-notification to venture capitalists (VCs) and the like about certain important matters. According to this clause, if a venture company or similar is involved in a dispute such as a lawsuit, if a bankruptcy or similar application has been made, if some problem arises in the venture company or similar and administrative measures such as business suspension orders are taken, or if a disaster causes significant damage to the company, the venture company or similar will be required to provide post-notification to VCs and the like.

Clause on Devotion to Management

In smaller-scale companies such as startups, the success of the business often heavily depends on the management. Therefore, for investors like venture capitalists (VCs), it becomes crucial to know who the managers are and how dedicated they are to running the business. As such, a clause regarding devotion to management may be stipulated in the investment contract.

Specifically, the following provisions may be included:

1. Clauses on the resignation or re-election of directors
2. Clauses on holding concurrent positions
3. Clauses on non-competition

By incorporating such clauses into the investment contract, it is expected to encourage managers to devote themselves to the management of startups and similar businesses.

Summary

We have explained the clauses related to the operation of a company in investment contracts. These clauses are important for both venture companies and investors such as Venture Capitals (VCs). In order for the company to grow smoothly and to achieve good results for both the company and the investors, it is necessary to carefully consider these clauses. Given the importance of these clauses in investment contracts, it is advisable to have a contract drafted by a legal expert, or to seek advice from a lawyer.