Down Round Financings

1. Down Round Financings Jan Peeters – Stibbe Brussels

2. Fiduciary Duties under Belgian law • Common law concept of “fiduciary duties” not known as such under Belgian law • exceptions • public take-over regulations • publicly listed company : obligation for directors to ensure equal treatment of shareholders

3. Directors Liability under Belgian law • “general law” standard of mandate • liability in case of violation of the articles or the Companies Act • specific liability in conflict of interest situation • disclose the conflict and justify decision (justification language to be taken up in annual report to shareholders) • transaction voidable at initiative of the company if procedure not followed • personal liability if, even when procedure has been complied with, unjustified financial benefit for the director to the detriment of the company • of limited application however to downround financings (not applicable when the board’s role in the transaction is limited to reporting to the shareholders and does not itself decide on the transaction)

4. Terms of earlier rounds • Preferred stock • Anti-dilution protection • Pre-emptive rights • Other provisions

5. Preferred Stock • Dividend Preference (can be cumulative) • Liquidation Preference • Sales Preference • Merger Preference • Not typically convertible in ordinary stock (but possible to structure convertibility into the terms) • Not “redeemable”

6. Anti Dilution Provisions • Company law restrictions on issuance of new shares without capital contribution being made, make it difficult to provide for typical anti dilution language in the terms of the shares as such • typically structured around by issuing “warrants” (entitlement to subscribe to new shares) with a low exercise price • law prohibits reducing the advantages granted to existing warrantholders • Dilution resulting from subsequent share issue at lower price is considered to be such a reduction of advantages • early exercise possibility in case of subsequent financing round against cash and where existing shareholders have pre-emptive rights • Usually this protection is contractually reinforced (to avoid the need to proceed to early conversion)

7. Pre-emptive rights • 2nd EC-Directive on company law • holders of existing stock are entitled to pre-emptive rights with respect to a subsequent issuance of stock against cash consideration • no pre-emptive rights upon a contribution in kind • conversion of bridge loan into capital is a form of contribution in kind • need to provide for contractual protection against dilution in case of capital increase further to a contribution in kind

8. Getting around pre-emptive rights • Who decides ? • Shareholders Meeting (supermajority) • Possibility to delegate to Board of Directors (for renewable periods of 5 years) • Subject to (special) board and auditor report(s) • Indication of reasons for restricting or lifting the preference rights and justification as to the issue price to be given in the board report • If the new shares are to be issued at a price below the “fractional” value of the existing shares, a separate special board report is required providing for a detailed justification of the issue price and the effect to the proposed transaction to the existing shareholders – • Each of these special board reports are to be supplemented by an auditor’s report confirming that the board’s report is sufficiently detailed to properly inform the shareholders

9. Getting around pre-emptive rights • Belgian law imposes further restrictions if pre-emptive rights are lifted to the benefit of one or more persons other than employees (additional board/auditors report) • Inform shareholdrs of identity of beneficiary • justify in additional report dilutive effect of the issue for existing shareholders • price restrictions • listed company : average of last 30 days trading • non-listed company : intrinsic value (shareholders consent or auditor’s valuation report) • net effect • no price reductions possible • need to comply with pre-emptive rights (or get individual waivers from each of the shareholders at the time of the down round)

10. Getting around pre-emptive rights • Shareholders/Board decision to increase share capital without lifting pre-emptive rights • Offer open to existing shareholders for 15 days (following notification to shareholders) • Shares not taken up by the shareholders can be freely offered to third parties (subject to any rights of first refusal stipulated in the articles) • Shareholders/Board decision to increase share capital while lifting pre-emptive rights but not to the benefit of “one or more persons other than employees” • No longer possible if deal with providers of new funds is already “done” or close to being “done” • Doing a “bridge loan” first and have it converted into capital at later date not really an alternative

11. Getting around other rights of existing shareholders • Change in rights attaching to a class of shares • Special board report • Overall supermajority vote in addition to a supermajority vote by class • Eliminate Existing Shareholders • So-called “accordeon” trick • wiping out incurred losses against capital account with corresponding cancellation of shares followed by capital increase against issuance of new shares • issues of equal treatment of shareholders

12. Additional protection possible ? • Strengthen supermajority requirements at shareholders level • be ware of decision rights with respect to board matters • de facto directorship – liability issue in case of subsequent bankruptcy • Redemption rights • difficult due to severe restrictions on share repurchases, including only out of distributable profits) • Co-sale rights • Drag along rights • Pay or Play provisions (uncommon) • Information rights • Employee Option Plans (tax issues)