It is not uncommon for a strategic investor to remain on the cap table after the business relationship that made the investment attractive has changed.
That is relevant when some rights were granted as a result of the investment itself and others were granted because the investor was expected to bring distribution, purchasing power, technology, market access, or another commercial benefit. If rights from both categories continue solely because the investor still owns stock, rights tied to the strategic relationship can continue after the company stops receiving the commercial benefit that supported them.
The company’s analysis does not turn on how many rights the investor receives. It turns on what each right is “buying,” and what has to remain true for that right to continue.
A strategic right should not automatically last as long as the investment.
The fact that the investor still owns equity does not necessarily mean a right tied to the strategic relationship should continue.
A right to maintain an ownership position in a later financing has a direct connection to the investment. Exclusivity, product priority, preferred commercial terms, or special access can be granted because the investor was also expected to perform a commercial role.
Using stock ownership as the same survival test for all of these rights can lead to unintended consequences.
The investor may continue to hold its shares even after a distribution program shrinks, a purchasing commitment ends, or a planned commercial rollout stops producing the value expected at signing. The result: a right that was reasonable as a benefit of the commercial deal can then continue for reasons unrelated to the deal itself.
The company has to separate the rights that protect invested capital from the rights supported by an ongoing strategic contribution. Some rights can continue for as long as the investor owns equity. Others should depend on whether the commercial relationship is still active or the investor is still delivering the value that initially supported the right.
The point is not to make strategic rights easy to terminate. It is to keep their duration tied to the reason the company granted them.
The investor may still need information after the strategic relationship changes
While an investor may continue to need financial and other information about the company after the strategic relationship changes, the level of access that came with its strategic role may not need to continue on the same terms.
Broader access can include board materials, product plans, pricing, customer pipelines, financing discussions, acquisition strategy, and negotiations with other partners.
The company should separate the information the investor receives in connection with its investment from the information it receives because of the strategic relationship. If the strategic relationship narrows or ends, the answer does not have to be full access or no access. The company may still have reason to provide information tied to the investment while limiting access that was tied to the strategic role.
A confidentiality provision can limit how the investor uses or discloses information, but the provision does not necessarily determine what information the investor should continue to receive.
The company may be giving up flexibility before the investor delivers
A strategic investor may ask for exclusivity, preferred commercial terms, product priority, or another benefit before it has delivered the distribution, purchasing volume, engineering support, market access, or other strategic value.
That does not mean every benefit should wait until performance occurs. The investment itself may justify part of what the investor receives at closing.
The company should decide what it is willing to give for the investment itself and what it is willing to give only if the expected commercial value arrives.
If the company gives up full exclusivity at closing before expected distribution or volume develops, it is taking more of the risk that the strategic plan does not materialize. That may be acceptable if the investment alone justifies the restriction. If it does not, some part of the commercial benefit can depend on what the investor actually delivers.
The company should be able to identify what it is receiving in exchange for what it is giving up, and when.
The investor may need protection without approval over the whole deal
A strategic investor may have a legitimate reason to care about a later financing, partnership, or sale. The issue is how far the protection needs to go.
If the concern is dilution, the investor may need protection tied to dilution. If the concern is losing a commercial right, the agreement can protect that right if the company enters another deal. Neither concern necessarily requires approval over an entire transaction.
A broad consent right can reach much further. It can give the investor leverage over a financing, partnership, or sale even when that transaction does not harm the interest the company originally agreed to protect.
The company therefore has to identify the harm the investor is trying to protect against before deciding how much control to give over future deals.
A broader consent right may still be part of the bargain. If it is, the company should be agreeing to that broader control deliberately, not because a broad approval right was used to solve a narrower concern.
The investment can outlast the relationship.
These issues usually arise when a financing and strategic relationship are negotiated together, or when an existing customer, supplier, distributor, technology partner, or other strategic counterparty becomes an investor.
The investment documents and commercial agreement may be negotiated at the same time, but the rights in each do not necessarily need to last for the same period or depend on the same conditions.
TKA Law Firm brings Wall Street transactions experience to fractional general counsel for companies preparing for financing, strategic partnerships, and exit. We advise on the contracts, IP, and deal documents that support those transactions, including deals where the investor also has a strategic role and the investment may last longer than that role.
This information is presented for general informational purposes only, is not for the purpose of providing legal advice, and is not intended to represent a full or complete list of all possible issues. This information should not be construed as legal advice and does not create an attorney-client relationship. You should seek the advice of an attorney regarding your particular situation.