Venture capital in future foods: key protections in articles of association in the UK

Future foods companies need to innovate fast, secure regulatory approvals and scale production, often across multiple funding rounds: balancing investor protections while maintaining founder engagement and incentivisation is, therefore, critical. A company's articles of association is one of the key documents used to achieve this balance.

Given the rapidly evolving regulatory environment and the emerging nature of consumer markets in the future foods sector, it is essential that investment terms provide flexibility to adapt to these regulatory changes and market shifts.

Unlike the shareholders’ agreement – which a shareholder must sign before it becomes binding on them – the articles automatically apply to all shareholders.

For the majority of venture capital (VC) transactions in the UK, the go-to starting point for what should be included in a set of articles is provided by the British Private Equity & Venture Capital Association (BVCA). As the VC industry body and public policy advocate in the UK, the BVCA promotes industry-standard legal documentation to streamline negotiations and allow parties to focus on sector and deal-specific matters.

Liquidation preferences: orderly exit economics

The liquidation preference known as the "waterfall" sets the order in which proceeds are apportioned between shareholders on a winding‑up or sale of the company. In this case, "proceeds" means the remaining shareholders funds available after the company has paid or provisioned for its debts.

While the waterfall can be negotiated in various ways and will evolve over time with each new funding round, a common starting point for a early-stage future foods businesses would be a 1x non-participating preference, as follows:  

• First, a nominal amount is paid to the class of deferred shareholders (usually, £0.01 in aggregate).
• Second, each of the preference "Series A" shareholders will receive a multiple of the price they paid on their investment (that is, the "preference amount").
• Finally, the balance of the proceeds (if any) is payable to the ordinary shareholders on a pro rata basis.

This is "non-participating" as the preference shareholders do not have the right to participate in tiers two and three. While a participating preference can be agreed, this is more "investor friendly" and should be considered carefully. The more customary and balanced approach is for the preference shareholders to have a right to convert their shares into ordinary shares prior to the liquidation event – that is, where conversion (resulting in participation in tier three as an ordinary shareholder) would yield a greater return.

Where a company is seeking EIS (Enterprise Investment Scheme) or SEIS (Seed Enterprise Investment Scheme) investment, legal and tax advice should be sought to ensure  tax reliefs and requirements are obtained.

Anti‑dilution: 'down round' protection

Anti‑dilution provisions protect the preference shareholders in the event that future shares are issued at an amount below the amount in which the preference shareholders subscribed for shares and are known as a "down round".

There are three widely accepted formulas for calculating the number of anti-dilution shares that should be allotted to preference shareholders on a down round; some being more or less friendly to new or existing shareholders. The most widely accepted formula is the "broad‑based weighted average" calculation. This is the approach promoted by the BVCA and is seen as the fairest and most balanced position for all parties.

Broad-based weighted average anti-dilution maintains the investor's economic entitlement by adjusting the investor's shareholding through a bonus issue of shares. The number of shares is calculated by weighting the fully diluted share capital (including options, warrants and other convertibles) of the company against the size and price of the new issue of shares. By contrast, more investor-friendly calculations (for example, narrow-based weighted average and "full ratchet") would have a greater dilutive effect on the founders and other non-participating shareholders.

Future foods businesses should carefully consider any investor request for more "investor friendly" anti-dilution protections (for example,  full ratchet protection). These are generally reserved for company's in financial distress and, crucially, can deter future investors. 

Pre-emption: swift capital and 'guardrails'

Pre-emptions offer swift capital raising with sensible "guardrails". The BVCA articles afford some or all of the existing shareholders a right of first refusal to acquire additional shares in the event that an existing shareholder wishes to sell some or all of their shares or the company proposes to allot new shares in order to raise further financing. This allows the relevant shareholders an opportunity to maintain or grow their stake in the company before third parties join the "cap table".

Notwithstanding this provision, future foods businesses will commonly seek to have these rights temporarily disapplied by resolution of the shareholders or with investor majority consent or both. This ensures the business can attract and continue to benefit from new strategic investment, which aids growth and introduces the right financial partners at each stage of development.

Future foods businesses often seek strategic investors, such as food industry corporates or impact funds, that can add value beyond capital. Articles should allow flexibility to bring in such investors without unduly restricting pre-emption rights.

New issues' pre-emptions

On a proposed allotment of shares, the BVCA articles adopt a streamlined contractual pre‑emption process for eligible shareholders (in substitution of the statutory regime). Typically, these rights are offered only to the preference shareholders or the major investors (those preference shareholders holding above a specific per centage of the preference shares).

The eligible shareholders will be offered to subscribe for the new shares on a pro rata basis within a prescribed period. Any remaining shares may then be offered by the company to third-party investors.

Restricted transfers

Transfers of shares are almost always restricted by the articles. An exception to such restriction is a transfer to a shareholder's “permitted transferees". This allows a shareholder to transfer shares within their corporate or fund group (for corporate shareholders), or to family members or trusts (for individuals). All other transfers will be subject to a right of first refusal in favour of some or all of the existing shareholders (as per the new allotments).

Irrespective of the prescribed pre-emption rights and permitted transfers, it is sensible for future foods businesses to retain the ability for the board to refuse to register transfers in certain scenarios, such as a proposed transfer to a sanctioned persons and/or a competitor of the company.

'Drag' and 'tag' alongs

"Drag along" and "tag along" provisions in the BVCA articles offer deliverable exits as well as fair treatment. To improve the deliverability of an sale proposed or agreed to by a majority of the shareholders, the BVCA articles provide for a right of the shareholder majority to compel all other shareholders – the minority –  to sell their shares as part of the same transaction. This is known as a "drag along".

In the event that a drag along is exercised, minority shareholders must be treated fairly and given adequate notice of the transaction. All terms applicable to the "dragged" minority shareholders must be no less favourable than those applying to dragging majority. In particular, future foods businesses should ensure that the consideration payable under a drag along are determined by reference to the liquidation waterfall and that each dragged shareholder is only required to warrant their title to the shares and capacity to enter into the agreement.

Where a minority shareholder fails to sign up to the transaction, the directors will be authorised to act as their agent to execute the sale on their behalf. It is, therefore, important to set an appropriate threshold that triggers the drag to balance shareholder interests.

Conversely, a tag‑along right protects the minority shareholders where a purchaser proposes to acquire a controlling interest (50% or more) in the company. In this case, the minority shareholders can compel the purchaser to acquire their shares on no less favourable terms than are being offered to the other (majority) shareholders.

Leaver provisions: retention and equity recycling

Future foods business and their investors will usually expect founders and shareholder-employees to remain engaged in the company for a restricted period. A three or four‑year restricted period is frequently adopted within the future foods industry.

Given the technical expertise required in future foods, it is especially important to ensure that key scientific or technical founders remain incentivised and engaged, with vesting schedules and leaver provisions tailored to reflect their critical role in the company’s success

To guarantee this continued engagement, the BVCA articles incorporate pragmatic "leaver" provisions, which govern the treatment of a leaver's shares. This is determined by the circumstances of the departure.

A "good leaver" (that is, a leaver as a result of death, disability, redundancy or termination without cause) will usually forfeit all entitlement to the "unvested" portion of their shares for nil consideration. The unvested portion is calculated by way of a formula that decreases on a straight-line basis over the restricted period. On day one, all shares would be deemed to be unvested; and, by the end of the restricted period, all shares would considered to have vested. The vesting schedule may also include a "cliff period" (for example, 12 months), whereby a good leaver would forfeit all shares irrespective of the circumstances.

In respect of a good leaver's vested shares, the economic benefit of the vested shares will be retained. This may be reserved for realisation until an exit or acquired at an earlier time at fair market value. If retained by the leaver until an exit, the articles may also suspend the voting rights attaching to the shares to ensure the leaver has no voting rights in the company.

By contrast, a “bad leaver” (that is, a leaver as a result of fraud, gross misconduct or early voluntary resignation) would generally be expected to forfeit all their shares for nil consideration.

Additionally, future foods businesses should adopt a wholistic approach to a leaver's package, including robust intellectual property (IP) assignment, confidentiality and proportionate restrictive covenants to protect the company's interest and assets.

Given the centrality of proprietary technology and know-how in future foods, articles should include robust provisions for IP assignment, confidentiality and non-compete obligations for founders and key personnel in order to ensure the company retains control over its core assets.

Osborne Clarke comment

Balanced articles underpin efficient fundraising and stakeholder interests throughout a company's lifecycle. These BVCA‑style provisions translate well to the realities and requirements of future foods businesses. Striking the right balance allows investors to protect their interests while enabling businesses to grow, innovate and create social and economic value.

As environmental, social and governance (ESG) considerations have become central to many future foods businesses. Companies may wish to reflect these ESG objectives in their articles; for example, by including mission-lock provisions or requiring board consideration of environmental and social impacts.

Danilo Santana, a paralegal at Osborne Clarke, contributed to this Insight.

Osborne Clarke has a market‑leading venture and growth capital practice across Europe, supporting investors, founders and companies in the future foods sector. If you have queries on any of the issues covered in this Insight, please connect with one of our experts.