NETHERLANDS Law and Practice Contributed by: Marc Habermehl, Jeroen Smits, David de Groot and Max de Heer, Stibbe
3.3 Investment Structure Different Types of Equity Ordinary shares and preference shares The share capital of a Dutch limited liability company ( besloten vennootschap met beperkte aansprakelijkheid ) (practically always the legal form of portfolio companies in the Netherlands) consists of ordinary shares/common stock. These ordinary shares are typically held in any event by the company’s founder(s), and some - times also by employees under an employee incentive plan. When the first early-stage investors make their investment, they generally require that they have a preference over these ordinary shares. For this purpose, they will be issued cumula - tive preference shares. This means that, in the case of a liquidation/exit event, they are the first to retrieve their investment, typically also with a certain return percentage. Only after the prefer - ence shares have received such amounts will the holders of ordinary shares receive proceeds. Liquidation preference: participating versus non-participating Preference shares arrangements may consist of “participating” or “non-participating” preference arrangements, as follows. Participating When the participating liquidation preference is agreed, the proceeds of the liquidation will be distributed among the holders of ordinary shares and the holders of preference shares, after the liquidation preference has been paid to the investors holding the preference shares. A participating liquidation preference can be subject to a cap, meaning that the investor is only entitled to the liquidation proceeds up to a certain amount.
Non-participating When the non-participating liquidation prefer - ence is agreed, the proceeds of the liquidation will be distributed among only the holders of ordinary shares after the liquidation preference has been paid to the investors holding the pref - erence shares. In addition, preference shares are usually con - vertible into ordinary shares. This is because if the company is performing well, and a non- participating liquidation preference or a par - ticipating liquidation preference with a cap has been agreed, holders of ordinary shares may be entitled to a greater share of the liquidation proceeds than holders of preference shares. In this context, the investor will prefer to convert its preference shares into ordinary shares, as it is more economically attractive to do so. (Convertible) shareholder loans Some VC funds invest not through equity but through (convertible) shareholder loans. The interest payable on the loan is typically not paid each year, but is added to the principal amount. Subsequently, in the event of liquidation, the entire outstanding amount should be paid to the investor. In this way, a comparable result is achieved to when the fund had invested in pref - erence shares. In the past, these shareholder loans were mainly used by UK and US investors. Such loans were typically tax-driven: in short, the (accrued) inter - est payable on such debt would generally be off - set against taxable income of the portfolio com - pany, aiming to reduce the corporate income tax payable by such portfolio company. Today, the tax reasons that traditionally drove choosing this type of financing have largely disappeared, mainly due to the fact that the deductibility of interest on both related-party debt and third-
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