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Conditions precedent to financing is legalese for “these things have to happen before this deal is actually binding,” which should be a reminder that term sheets are usually not legally binding documents. This part of the term sheet can range in size, may include several items, and, as Brad Feld writes, “if you can dream it, it has probably been done.” Common items include, per Brad Feld:
“approval by investors’ partnerships”
“rights offering to be completed by company”
“employment agreements signed by founders as acceptable to investors.”
Drag-along agreements are important in the event of an acquisition. Under Delaware law, the general standard is that a majority of the outstanding shares have to vote in favor of an acquisition—common and preferred voting together, a majority of the stockholders have to vote in favor of selling the company. At the time of an acquisition, however, almost every acquirer will require a supermajority (usually 85–95% of stockholders) to vote in favor of the deal. A simple majority of 51% leaves the acquirer open to the risk of 49% of the company opposing the deal and creating trouble through lawsuits.
DefinitionDrag-along agreements (or the drag-along provision) require certain minority shareholders to comply with a transaction approved by a specified majority percentage of shareholders.* In the context of venture capital term sheets, VCs are often majority shareholders while founders are minority shareholders.* Transactions that commonly trigger drag-along agreements include a sale of the company to, or a merger with, another entity.
While drag-along agreements are primarily designed to protect majority shareholder rights and make companies more attractive for acquisition, they also benefit minority shareholders by ensuring they receive the same transaction terms as the majority shareholder(s).* However, founders should be careful with drag-along agreements because investors can use these agreements against them.
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