Investors in life sciences and other technology companies face the potential of both high risk and high reward. One technique for reducing some of that risk is by requiring certain special buy/sell rights.
When you invest in a high-tech company, you are investing in the people who are involved as much as in the technology. If a founder leaves the company, or a new shareholder takes control, your shares could become less valuable. If the company sells new shares to a third party, your percentage interest in the company could shrink. So, it’s important to consider how to protect yourself in those cases.
A right of first refusal gives you the option to purchase some or all of the shares of a founder if, for example, the founder wishes to sell his or her shares to a third party. This can block or limit the ability of a new third party from assuming the outgoing founder’s stock position.
“Pre-emptive rights” require the company to offer you shares from a new stock offering in proportion to your current overall interest in the company. For example, if you own 5 percent or a company, the “pre-emptive rights” (usually set forth in the corporate charter) would give you the right to purchase 5 percent of the new stock offering.
Special rights can also protect you if you decide not to exercise your right of first refusal and a founder sells shares. “Tag-along rights” can give you the option to sell shares proportional to your investment under the same terms and conditions offered to the founder. If the prospects of the company have diminished, it wouldn’t be fair for the founder to sell his or her shares while you still have yours. Similarly, if the company has done well it’s not fair for the founder to exit with a gain and leave minority stockholders without a means to participate.
Investing in technology companies is risky. Carefully crafted written agreements and charter provisions can go a long way toward reducing or at least controlling a portion of that risk. The discussion above gives you insights into some of those risks – and there are more.
If you’re looking at investing in a new or existing company, take some time to an experienced attorney who understands your teh high-tech industry and the law.