Investors in a start-up care about more than preferential rights. They also want a say in how the shareholder structure develops, above all when shares are sold. Transfer restrictions in the shareholders’ agreement cover exactly this. They set out how shares can be sold and when they must be sold. Below is a practical overview of the main tools, based on Swiss practice.
Permitted transfers: the exceptions
Where there are restrictions, there are exceptions. Shareholders’ agreements therefore usually list transfers that fall outside the general rules. Typical examples are:
- estate planning under inheritance law;
- transfers due to divorce or other transfers to family members;
- transfers to a privately held company owned by a private shareholder.
These exceptions matter most for private individuals. They can keep managing their private affairs without hitting a block. Investors, in turn, usually reserve the right to move shares within their own group of companies. In short, transfer restrictions target sales to third parties. Family and intra-group transfers for succession planning are not their purpose.
Right of first refusal
A right of first refusal lets certain shareholders buy shares before a third party does. However, they can only do so on exactly the same terms the third party would have had.
The parties can set the order of priority freely. For example, the right often goes first to the class with the highest preference. Then it cascades down to the next class, unless the priority group has already bought everything. Rights are also possible within the class of the selling shareholder. After that, the right passes to other classes along the agreed cascade.
The start-up itself often gets a preemptive right too, either at the start or later in the cascade. Yet it may be legally unable to use it. Under Swiss law, a company may hold at most 10% of its own shares, or 20% in exceptional cases. It also needs freely available reserves, or the ability to create them. So if a major shareholder sells, the start-up may only be able to buy part of the stake, even with priority.
One variant is the least favourable for founders. In that case, the right covers only common shares, while investors sell their preferred shares freely.
Drag-along right
In a company sale, the drag-along right is probably the most important restriction. It obliges a shareholder to sell to a third party once a defined drag-along event occurs. That shareholder usually stays out of the negotiations. Even so, they must accept the agreed terms and join the sale.
The agreement sets hurdles before the obligation can be enforced. The most common one is a minimum share of capital held by the willing sellers, for example at least 50%. Once the conditions are met, the dragged shareholders must sell. If they refuse, the obligation can be enforced in court.
Tag-along right
Other shareholders may sometimes join a sale to a third party. Unlike with drag-along, the holder of a tag-along right decides freely whether to use it. As a result, they can share in the success of another shareholder’s negotiations. At the same time, they can stay on as a shareholder and skip the sale.
Purchase option
The agreement may also give a general purchase right. It lets one shareholder buy another’s shares with no third party involved. Typical triggers are:
- breach of the shareholders’ agreement;
- insolvency;
- criminal acts by a shareholder that harm the company or other shareholders.
This right works like a contractual penalty. Its purpose is to stop one shareholder’s destructive conduct from harming everyone else in the start-up.
Reverse vesting for founders
Founders often face a repurchase obligation as well. The earlier the investment and the deeper the founder’s involvement, the more important it becomes. Usually it comes with a non-compete clause. Together, they give the founder an incentive to stay fully committed after the investment.
The obligation sets conditions and deadlines. Conditions cover the reason for leaving. Deadlines cover how soon after the investment the founder leaves. If the founder ends their engagement early, they must sell part of their shares back to the start-up.