The principle of loyalty in venture capital shareholders' agreements

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Title: The principle of loyalty in venture capital shareholders' agreements
Author: Fagerström, Maria
Other contributor: Helsingin yliopisto, Oikeustieteellinen tiedekunta
University of Helsinki, Faculty of Law
Helsingfors universitet, Juridiska fakulteten
Publisher: Helsingfors universitet
Date: 2014
Language: eng
Thesis level: master's thesis
Discipline: Obligation law
Abstract: The primary objective of this thesis is to assess whether the contractual principle of loyalty affects a venture capital shareholders’ agreement and in what extent. The secondary objective of this study is to analyze whether a venture capitalist needs to be loyal towards the founding shareholders of a portfolio company and vice versa. Venture capitalists are professional investment companies or institutional investors that provide early-stage, high-potential, and high-risk investment to growth start-up companies. The venture capitalists often invest in companies that are going through some kind of revolution. The venture capitalists can be everything from so called business angels to public venture capitalists and their investment activities are usually practiced through limited partnership corporations. The key motivators for venture capitalists to conclude a shareholders’ agreement can be divided into two groups. Firstly, the agreement is used as a control instrument by the venture capitalist for it to be able to affect the portfolio company’s business and increase its value. Secondly, the agreement is used as a risk management instrument by the venture capitalist to ensure that the invested capital remains. Thus, the shareholders’ agreement is used as a tool for allocation of risk between the contracting parties. It can be emphasized that the duty of loyalty plays a key role in agreements were the parties have mutual interests, such as co-operational agreements. Further, if the agreement is long-term, it highlights the importance of the principle. Loyalty shall govern the behavior of the parties, whether it is at the moment the obligation comes into existence, during its performance or the moment it is extinguished. On the basis of the principle of loyalty, other duties are also imposed on the parties to the venture capital shareholders' agreement. The parties are expected to contact and inform each other, co-operate and discuss any problems they are facing, renegotiate the agreement, keep secret information secret and contribute to their contractual goals. Under the Companies Act the management of the company shall act with due care and promote the interests of the company. This duty is called the management’s fiduciary duty and entails that the management shall act loyally and with care towards the company and its shareholders. In close corporations all the shareholders are active and want to participate in the conduct of the business of the company and decide mutually of the corporation’s management structure. Further, in venture capital investments, the investor often requires the same control rights as the management of the company usually has. Therefore, the question that arises is whether the parties to the shareholders’ agreement, especially the venture capitalist, shall act loyally towards other shareholders and if the controlling shareholder is fiduciary towards the minority. The venture capitalist is often considered to have control over the portfolio company even though the investor de facto often only has a minority of the stakes in the company. Therefore, two issues are to be determined in this study: firstly, whether the venture capitalist can be regarded as a controlling shareholder and secondly, if this is the case, whether the venture capitalist has a certain fiduciary duty towards the founding shareholders.

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