The legal negotiation of corporate governance in corporate finance transactions in France

Wednesday 29 November 2023

Renee Kaddouch
Squair, Paris

Corporate governance is a set of rules that a company decides to adopt to balance the powers within its management, leadership and more generally between all stakeholders. One of its main objectives is to ensure that leaders manage the company’s finances effectively and always act in the best interest of the company. As a result of a good governance, a company’s performance is enhanced, and it can generate maximum value for stakeholders.

Negotiating the governance rules that are applicable post-closing in a corporate finance transaction is crucial – whether the transaction is a round of funding, an leveraged buyout (LBO) operation or even an acquisition. For example, the governance rules between buyer and seller (who usually remains in the company, with or without shares) can have a direct impact on the later payment of the earn-out. In many ways, governance is a strategic issue in corporate finance operations.

Governance is usually implemented through the establishment of a collective body, other than the shareholders’ meeting. This is either mandated by law, as in a société anonyme (equivalent to a public limited company) or by the shareholders’ will through the statuts (articles of association) in other forms of companies.

Under French law, except for société anonyme, this collective body does not run the company. The opposite solution prevails in common law countries where the board of directors is the ultimate ruler of the company. In sociétés par actions simplifiées (the most common form of French startup, and more generally of non-listed companies) the collective body is optional; when it exists, it is not meant to manage the company. The management power belongs to the executives (the président – the equivalent of the chief executive officer (CEO) under French law) and, if applicable, directeur general (deputy CEO) alone. The members of the collective body are not usually considered as managers of the company, unless the statuts (articles of association) body is only a supervision body with an advisory role. For the sake of convenience, we will refer to it as ‘the board’.

Despite its crucial importance, governance is often neglected during the negotiation phase. In fact, the functioning of companies tends to become burdensome after closing: this can harm their performance, especially when the financial and/or commercial situation becomes challenging. Well-negotiated governance upfront could largely avoid this pitfall in two ways:

  • by paying increased attention to the composition of the board; and
  • by ensuring proper definition of the board’s powers.

Composition of the board

The composition of the board is governed by the shareholders’ agreement, some provisions of which may be included in the statuts. However, attention should be paid to ensure that no provision contradicts a clause in the shareholders’ agreement. Even though the superiority of the statuts over the shareholders’ agreement is no longer affirmed as clearly as before by case law, it is advisable to eliminate any clause of the statuts that may contradict the agreement.

In venture capital or LBO transactions,[1] investors usually ask for the right to appoint a candidate in addition to the candidates put forward by the founders (or managers, in case of an LBO) at the general shareholders’ meeting held on the closing date. Hence, there is a double risk of having an oversized board. It is crucial to maintain a compact team for in-depth discussions among members of the board and better board dynamics at all stages of the company’s lifecycle. The ideal size for young companies is usually three to five members, and six to eight for more mature companies.

Firstly, the risk of an overly expanded board could stem from granting a board seat to each investor in the funding round, if applicable. This pitfall can be avoided by asking investors to choose a single candidate to represent them on the board, which is easier as investors’ interests are aligned.

Secondly, even if only one seat is allocated for all investors in round N, there is a risk of increasing the size of the board in round N+1 by appointing a candidate presented by the investors of that round, and so on. In order to limit this ‘inflationary’ risk, the shareholders’ agreement may provide for a threshold of ownership (generally appreciated on a fully diluted basis) below which investors lose their seat on the board. The threshold will obviously be fiercely negotiated as the lower it is, the more chance investors have of retaining the right to appoint a board member over successive rounds. However, if the threshold is too low, it would be ineffective in limiting the risk of increasing the size of the board with each successive funding round. The generally accepted threshold is usually between 10–15 per cent of the shares.

Powers of the board

Negotiators should also pay close attention to the powers of the board. The board is only an advisory body responsible for assisting the management in decision-making. Decisions are normally made by majority vote of the members of such board. Therefore, founders must ensure that the members they have appointed remain in the majority.

The investor may propose that certain specifically listed decisions be subject to prior approval by the board via majority vote (including the favourable vote of the board member representing the investor).

As a matter of practice, this right, known as the ‘veto right’, indirectly allows the investor to oppose the adoption of these decisions.

Consequently – and paradoxically – this veto right is an instrument of good corporate governance as it encourages the management to consult with the board before making important decisions subject to veto. This ensures that the vote becomes a mere recording of an informed decision made prior to the board meeting. Ultimately, this facilitates communication within the company, benefitting all stakeholders.

Decisions subject to the veto right can be grouped into several categories. These usually include:

  • decisions regarding the remuneration of founders/executives or key employees;
  • those concerning potentially dilutive operations for existing investors (such as issuing shares or securities giving access to the share capital through bons de souscription de parts de créateurs d’entreprise (warrants for employees or managers));
  • those concerning the yearly budget or business plan; or
  • those falling outside the normal course of business.

In the latter case, this would include operations representing a major expense for the company (such as incurring an expense exceeding a certain amount not included in the yearly budget), a risk to its assets (such as granting guarantees over assets), a change from the initial conditions of the investment (such as a modification of the business), an external growth operation, or the liquidation of the company itself.

Investors must ensure that they do not obtain veto rights that exceed their supervision power and in turn provide them with actual management powers or interference rights in the management. In such cases, they may incur the qualification of being dirigeants de fait (de facto managers), exposing them to the same sanctions as actual corporate officers (such as an action for shareholder liability, for example). Indeed, investors have been recognised as dirigeants de fait just because the board they were part of had to give prior authorisation for any operation exceeding a very low amount.[2] This risk is even greater for a private equity fund if all other conditions are met, as it may be accused of mismanagement due to the involvement of its representative on the board.[3] Therefore, investors must remain vigilant and avoid being granted the means to interfere in management due to the significant veto rights they have obtained during negotiations. For example, the shareholders’ agreement should not include the power to define the company’s strategy, which falls under management power, among the prerogatives of the board, and, a fortiori, should not grant a veto right to the board member appointed by the investors.

The veto rights negotiated can be of crucial importance, as per the following two examples:

Firstly, investors may seek veto rights ever an exit, such as the sale of the company or an initial public offering (IPO). It is crucial to remember that founders are rewarded for their efforts and sacrifices, and investors realise their expected capital gains from their initial investment upon the exit event (IPO or sale). Granting veto rights to investors allows them to block a majority sale of the company if they find the terms unfavourable, particularly if the expected capital gains are deemed insufficient.

Secondly, in relation to acquisitions, the board member(s) representing the buyer who have been granted, for example, veto rights on expanding into new markets, may exercise these rights with consideration for the potential impact on the subsequent payment of the earn-out to the seller, rather than the commercial interest of the transaction.

Negotiating the rules regarding the composition and powers of the board is crucial for the success of corporate finance transactions and the financial performance of the company. This ultimately enables a successful outcome for all parties involved, either through satisfactory terms for all in the exit (in the case of private equity transactions), or through the successful integration of the acquired company into the buyer’s group (in the case of acquisitions).


[1] Or in case of an acquisition by tranches, the buyer.

[2] Cour d’appel (Court of Appeal) of Paris, 23 February 2016.

[3] The Cour de Cassation (French Supreme Court) recognises gestion de fait (de facto management) by an intermediary ‘through the intermediary of a natural person chosen by the intermediary and who has acted under the intermediary’s control, powers of management over the company’ (Cass. Com., 27 June 2006, Bull. civ. IV, no. 151).