When founding a startup (also referred to as a start-up), one of the most crucial aspects to consider is drafting the articles of association, a legal document that regulates the relationships between shareholders and the management of the company. The articles of association and the incorporation deed determine the company’s structure, protect the interests of founders and investors, and lay the groundwork for future growth.
In this article, we will explore the key statutory clauses to include in a startup’s articles of association, providing practical examples for each. Additionally, we will analyze the importance of these clauses in real-world contexts and their practical implications. To support this guide, a summary table is included to facilitate understanding.
What is the Articles of Association of an Innovative Startup?
The articles of association is the fundamental document that governs the internal organization of a startup. It defines the relationships between shareholders, the rights and duties of each party, management procedures, and the rules for handling share capital and profit distribution.
For innovative startups, this document is especially important because it establishes the legal foundation on which the company can grow and thrive. One of the most interesting aspects of startups is the ability to include flexible contractual clauses, which can be tailored to the high-tech nature of the business and its growth potential.
Key Clauses to Include in the Articles of Association of an Innovative Startup
Clauses included in the articles of association should protect the company and its shareholders from potential future disputes. Below are the most relevant clauses, along with practical examples of how they can be applied.
Good Leaver and Bad Leaver Clauses
These clauses manage situations where a founding shareholder leaves the startup. They distinguish between those leaving for justified reasons (Good Leaver) and those leaving without a valid reason (Bad Leaver).
Good Leaver Example: Mario, a founder, is forced to leave the startup due to a serious illness. According to the Good Leaver clause, his shares can be purchased by the remaining shareholders at market value. This prevents Mario from suffering unfair financial losses and ensures a smooth transition.
Bad Leaver Example: Anna, another founder, leaves the startup without notice to join a competing company. The Bad Leaver clause allows the other shareholders to buy her shares at a discounted price, e.g., 50% of market value, penalizing opportunistic behavior.
Shareholder Exclusion Clause
The exclusion clause regulates circumstances under which a shareholder can be forced to exit the company, such as misconduct or failure to meet contractual obligations.
Example: Giovanni, a shareholder, is caught using company funds for personal purposes. The exclusion clause allows other shareholders to remove him from the company, forcing him to sell his shares and protecting the startup from harmful actions.
Pre-emption Rights Clause
The pre-emption clause ensures that if a shareholder wants to sell their shares, they must first offer them to the other shareholders. This prevents unwanted third-party investors from entering the company.
Example: Luca wants to sell his 10% stake to an external investor. Under the pre-emption clause, he must first offer the shares to the other shareholders, who have the right to buy them on the same terms as the external investor.
Co-Sale Clauses (Tag Along and Drag Along)
These clauses are essential in the event of share transfers, involving both majority and minority shareholders.
Tag Along: Protects minority shareholders by granting them the right to sell their shares under the same conditions as majority shareholders.
Example: Marco, a majority shareholder with 60%, decides to sell his shares to an external investor. Thanks to the Tag Along clause, Sara, who owns 10%, can sell her shares under the same conditions offered to Marco.
Drag Along: Allows majority shareholders to force minority shareholders to sell their shares in the event of a full acquisition.
Example: In a company acquisition, Alessandro, the majority shareholder, wants to sell 70% of the shares. With the Drag Along clause, he can compel minority shareholders to sell their shares, enabling the buyer to acquire 100% of the company.
Bring Along Clause
The Bring Along clause is similar to Drag Along, but in this case, it is the buyer who requests the acquisition of all shareholder shares.
Example: A large corporate group wants to acquire the startup and requests that all shareholders sell their shares. Thanks to the Bring Along clause, the buyer can acquire full control, including minority shares.
Share Classes and Voting Rights
In an LLC, it is possible to create different classes of shares with varying rights. For example, some shares may have different financial rights or no voting rights, helping founders retain control.
Example: The startup issues new shares to raise capital, but these shares have no voting rights. This allows founders to maintain control over company governance while accessing new funding.
Profit Distribution Limitation Clause
This clause ensures that profits are not immediately distributed among shareholders but are reinvested in the startup.
Example: The startup closes the year with a profit of €100,000. Thanks to the profit limitation clause, 70% of the profit is reinvested in product development, while 30% is distributed among shareholders.
Summary Table of Key Clauses for Innovative LLCs
| Clause | Description | Practical Example |
|---|---|---|
| Good Leaver / Bad Leaver | Manages shareholder exit for justified or unjustified reasons | Mario leaves due to illness (Good Leaver), Anna leaves for a competing startup (Bad Leaver) |
| Shareholder Exclusion | Rules to force the exit of a shareholder violating obligations | Giovanni uses company funds for personal purposes |
| Pre-emption | Obligation to offer shares to other shareholders before selling to third parties | Luca must offer shares to existing shareholders before selling to an external investor |
| Tag Along | Protects minority shareholders, allowing them to “tag along” in share sales | Sara can sell her shares under the same conditions offered to Marco |
| Drag Along | Majority shareholders can force minority shareholders to sell shares | Alessandro forces minority shareholders to sell in an acquisition |
| Bring Along | Buyer can request acquisition of all shares | Buyer acquires 100% of the startup |
| Share Classes | Creation of shares with different rights, e.g., no voting rights | Investors get non-voting shares to protect founders’ control |
| Profit Distribution Limitation | Profits are reinvested instead of being distributed | 70% of profits reinvested in product development |
Conclusion
Drafting a solid and comprehensive articles of association is an essential step for the success of any innovative startup. Clauses such as Good Leaver, Bad Leaver, Tag Along, and Drag Along protect both founders and investors (including angel investors or venture capital funds), prevent future conflicts, and support company growth.
Before drafting the articles, it is advisable to consult a corporate law attorney to ensure that each clause is tailored to the startup’s specific needs and complies with current regulations. A strong legal foundation from the beginning can make a significant difference in the long term.
