No venture capital fund, no family office and no industrial investor takes an equity stake in a company without a shareholders’ agreement. Many founders approach their first fundraising round thinking that the articles of association will be enough, then quickly discover that company law covers only part of the issues. The shareholders’ agreement, a confidential and flexible agreement outside the articles of association, fills this gap by organising what the articles do not contain: exit mechanisms, investment protection and founder retention.
Pre-emption, anti-dilution, bad leaver, liquidation preference: behind this term sheet vocabulary lie the balances that founders and investors negotiate inch by inch.
I. The shareholders’ agreement: a contractual instrument separate from the articles of association
A shareholders’ agreement is an ordinary contract. Its binding force rests on Article 1103 of the French Civil Code[1]: it has the force of law between its signatories, no more and no less. Unlike the articles of association, which are enforceable against third parties once filed with the court registry, the agreement binds only those who signed it. It is not published and it is not filed with the Trade and Companies Register. This confidentiality makes it the instrument of choice for investment transactions.
Three structural reasons explain why the articles of association are insufficient. First, their public nature: filed with the court registry, they are accessible to anyone, which an investor negotiating a discount does not want. Second, their rigidity: any amendment requires a collective decision and a filing with the registry, whereas the agreement can be amended by simple consent. Finally, their generality: the articles apply uniformly, whereas investment commitments are by nature asymmetric.
Point to watch: how the articles of association and the agreement fit together in an SAS
In SAS companies, certain clauses must appear in the articles of association to benefit from the statutory sanction (lock-up, approval, exclusion, change of control[2] etc.), because only transfers in breach of the clauses of the articles are void[3]. Good practice: mirror in the articles of association the clauses of the agreement for which nullity is sought as the sanction.
II. The essential clauses required by investors
Behind the technical nature of a shareholders’ agreement’s clauses, the investor’s logic comes down to three fundamental concerns: controlling who holds the capital, preserving the value of its stake, and ensuring that the founding team remains committed.
A. Controlling entry into and exit from the capital
Every investor’s first concern is the make-up of the cap table. It does not want to discover, in the course of a share transfer, that a competitor or an undesirable third party has become a fellow shareholder. The pre-emption right and the approval clause[4] address this risk upstream: the former gives existing shareholders priority to buy the shares being transferred, the latter makes any transfer subject to the company’s approval.
But controlling entry is not enough: exits must also be organised. The joint exit right (tag-along) protects the minority shareholder by allowing it to sell its shares on the same terms as the majority shareholder if the latter sells its stake. Conversely, the drag-along allows the majority shareholder to bring the minority shareholders into an overall sale, thereby preventing a reluctant shareholder from blocking an exit that the majority wants.
Together, these four mechanisms form a complete lock: no one enters without consent, and no one leaves without offering priority.
| Clause | Purpose | Beneficiary | Risk if absent |
| Pre-emption | Priority right to buy the shares being transferred | All shareholders | Uncontrolled entry of a third party |
| Approval | Prior approval of any transfer | The company | Dilution of control with no recourse |
| Tag-along | Joint exit on the same terms | The minority shareholder | The minority shareholder remains locked in |
| Drag-along | Forced sale of all the shares | The majority shareholder | Exit blocked by a minority shareholder |
B. Preserving the value of the investment
The investor takes an equity stake at a given valuation. The whole challenge is to protect this initial stake against two distinct risks: dilution through a later round at a lower valuation (down round), and outright loss in the event of a sale or liquidation at an insufficient price.
The anti-dilution clause, combined with a ratchet mechanism, addresses the first risk. In a down round, the investor receives additional shares or has its entry price adjusted. A full ratchet realigns the price entirely with the new valuation; a weighted average weights the adjustment according to the size of the new round.
The liquidation preference addresses the second risk: it guarantees the investor priority repayment (of its investment, or even a multiple of it) before any distribution to the founders.
These clauses are not without limits, however. Freedom of contract comes up against the prohibition of leonine clauses[5]: the drafting must therefore be calibrated so as not to grant one shareholder all of the profit or exempt another from all losses.
C. Governing the departure of founders
The investor is betting as much on the project as on the people behind it. The departure of a key founder is a major risk that the agreement anticipates through two complementary mechanisms.
The bad leaver clause provides that, in the event of a departure for cause (gross misconduct, resignation before term), the founder transfers his or her shares at a reduced price. The good leaver clause covers departure without fault (dismissal, disability, death) and provides for a transfer at fair value.
The lock-up clause completes the arrangement by prohibiting any transfer by the founders for a fixed period aligned with the investment horizon. In an SAS, this lock-up may last up to ten years.
Point to watch: employee founders and the shareholders’ agreement
Where the founder is also an employee, the agreement must be concluded with an entity separate from the employer (the top holding company, for example) to avoid the bad leaver clause being recharacterised as a prohibited financial penalty (Art. L. 1331-2 of the French Labour Code).
III. Enforcement and sanctions of the agreement
The shareholders’ agreement has a structural weakness that every practitioner must bear in mind: a breach of it is not enforceable against third parties acting in good faith. Unlike clauses in the articles of association, breach of which renders the transfer void, breach of an agreement outside the articles gives the injured signatory only two remedies: specific performance and damages.
In return for this fragility, the agreement offers a guarantee that the articles of association cannot provide: control over the transfer price. Where a founder is required to transfer his or her shares under a bad leaver clause or a promise to sell, the price set by the agreement prevails. The Commercial Division of the French Supreme Court (Cour de cassation) confirmed this in a judgment of 14 November 2018[6]: Article 1843-4 of the French Civil Code, which normally allows a court-appointed expert to be designated to set the transfer price, does not apply where the transfer results from a promise freely given in an agreement outside the articles of association (unless otherwise stipulated). In other words, a founder who has accepted an exit discount cannot, when the time comes, ask the court to revalue the price upwards.
To make up for the agreement’s weakness vis-à-vis third parties, the technique of mirroring in the articles of association is therefore essential: by reproducing the key clauses of the agreement (pre-emption, approval, exclusion) in the articles, nullity as the sanction for breach is combined with confidentiality of the financial terms, which remain in the agreement.
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The shareholders’ agreement is not an accessory to the fundraising. It is its keystone. It is the document in which the balance between founders and investors takes shape and the rules of the game for the years ahead are defined. Each clause is a trade-off between protection and flexibility, and a good agreement anticipates tensions without creating them.
Because the best time to renegotiate a shareholders’ agreement is before you need to, Bruzzo Dubucq assists founders, investors and groups in structuring and negotiating their shareholders’ agreements.
[1]Article 1103 of the French Civil Code: “Contracts lawfully entered into have the force of law for those who made them.”
[2]Articles L. 227-13 to L. 227-17 of the French Commercial Code, concerning lock-up, approval, exclusion and change of control clauses in SAS companies.
[3]Article L. 227-15 of the French Commercial Code: “Any transfer made in breach of the clauses of the articles of association is void.”
[4]Article L. 227-14 of the French Commercial Code: “The articles of association may make any transfer of shares subject to the prior approval of the company.” See also Art. L. 228-23 C. com. for unlisted SAs.
[5]Article 1844-1 of the French Civil Code, para. 2.
[6]Cass. com., 14 November 2018, No. 17-15.828: Article 1843-4 C. civ. does not apply to a transfer resulting from a promise freely given in an agreement outside the articles of association. See also Cass. com., 6 May 2014, No. 13-17.349.
