Industry insight article – fundraising 101: An Overview on Reserved Matters

1. What are “Reserved Matters”?

As a company raises more funds and welcomes new investors to its capitalisation table, founders should expect that control in the form of governance rights will get sliced and diced in more ways than one. The interests of different groups (and sometimes even sub-groups) of shareholders could diverge and vary in multiple aspects in this regard. Founders may wish to still retain the majority of management control on the premise that they know the business best, but investors may also want a larger piece of the control pie given the monies they have invested. Even among investors, the investors in the later funding rounds, those with seniority in their preferential rights or those who put in larger cheque sizes may also wrestle for more influence vis-à-vis themselves and against the earlier and minority investors.

This is where reserved matters (or veto rights) come in as an instrumental tool in the toolbox of governance rights. Reserved matters are specific decisions or actions that require the approval of a defined group of persons (for example, particular identified shareholders, the specified majority of shareholders, or the board of directors) before they can be implemented by the company and often expanded to cover its subsidiaries and/or group companies. The primary purpose of including reserved matters in a company's constitutive documents is to protect the interests of shareholders, particularly minority shareholders, by ensuring that decisions which are particularly key to them would not be made unilaterally without their consent. This becomes even more important given that shareholders may not be as involved in the company's day-to-day management and operations as opposed to the board of directors. Reserved matters also seek to ensure that there is sufficient scrutiny and checks and balances in the operations and processes of the company, and that pivotal decisions that affect a company will be made strategically and with careful consideration.

By ensuring that reserved matters are properly delineated in a shareholders' agreement, founders and investors alike can be aligned to ensure that decisions are made with the appropriate level of oversight and consent, thereby promoting good corporate governance and ensuring that the interests of all stakeholders are sufficiently protected.

2. Types of reserved matters, considerations and approval thresholds

Board and shareholder reserved matters

Reserved matters can be broadly categorised into board reserved matters and shareholder reserved matters. Board reserved matters are decisions that would primarily relate to salient operational and strategic decisions affecting the company and would require the approval of a specified group of directors. Which directors would constitute this specified group would typically be subject to commercial negotiation but can take the form of (a) an agreed proportion of the board of directors; (b) an agreed proportion of specified directors (typically directors appointed by investors); or (c) most restrictively, the consent of specifically identified directors (again, typically directors appointed by investors).

Shareholder reserved matters, on the other hand, usually relate to matters affecting the interests of shareholders and would commonly require the approval of a specified group of shareholders. This specified group of shareholders would similarly be subject to commercial negotiation and can take the form of (a) an agreed percentage of shareholder votes; or (b) approval from the holders of a specified majority of shares of a certain class or series of shares (typically preference shares held by investors); or (c) the consent of specified shareholders (typically investors). This distinction ensures that both the board and shareholders have appropriate levels of decision-making power over the company's key decisions.

When deciding whether a particular matter should be designated as a board reserved matter or shareholder reserved matter, there is an ideological distinction in that board reserved matters typically relate to the day-to-day management and strategic direction of the company, whereas shareholder reserved matters relate to matters which are more significant and fundamental to the company's existence. This distinction also translates into a competing tension between speed and degree of control. For a traditional company where the size of the board is smaller than the number of shareholders, it would typically be easier for the company to obtain reserved matter approval if the reserved matter is at the board level.

It is important to bear in mind one key differentiation between board reserved matters and shareholder reserved matters, namely that a director owes fiduciary duties to the company whereas a shareholder does not. Directors owe fiduciary duties to act in good faith and in the best interests of the company, and therefore have to bear these duties in mind when voting on board reserved matters. Conversely, shareholders do not owe such duties and are not constrained as such when voting on shareholder reserved matters. They can essentially vote as they like, how they like.

Operational efficiency versus minority shareholder protection

Another question that the company should consider is whether operational efficiency in keeping the business running will be hampered or sacrificed with the addition of numerous shareholder reserved matters in a potentially overzealous attempt to maximise minority shareholder protection. A long list of shareholder reserved matters may add complexity and further hoops to jump as time could be wasted in chasing down signatures or if certain required shareholders are unresponsive. This affects the company's ability to make timely decisions and respond to market opportunities swiftly. The aim of minority shareholder protection should therefore always be delicately balanced against operational efficiency.

Founder reserved matters

During the funding bonanza between 2021 and 2022, we have also observed that some founders who have leverage tried to include founder-specific reserved matters during the negotiation process. Such founder reserved matters would mean that founders have a veto right over the specified matters. By reserving certain matters for their approval, founders can ensure that the company stays true to their original vision and goals. Typically, investors in Southeast Asia would push back quite strongly on this point. There are a couple of reasons for this. First, unlike minority shareholders, founders typically retain most or a good part of management control and shareholding of a company and as such, they are still very much involved in the decision-making process of the company. This means that the argument of minority shareholder protection does not quite hold water here – without the buy-in of the founders, decisions would not typically reach the board and/or shareholders for determination. Second, the interest of founders (to whom the company is very much their baby) may not necessarily be aligned with the interests of the investors. There are concerns from an investor's perspective on how the company may be affected if founders have blocking rights in extreme situations involving fraud or dismissal for "cause" of the relevant founder.

In such cases of founder fraud or dismissal for "cause", it becomes even more crucial to have mechanisms in place to suspend a founder's rights to prevent such a founder from obstructing necessary actions to be taken to ensure that it is business as usual notwithstanding the fraud or dismissal. A company could consider including certain provisions defining events of default and their consequences in its constitutive documents. One possible construct may be that for the time an event of default remains unremedied, the shares held by such errant founder shall be suspended and he or she shall not be entitled to exercise the rights relating to such shares, including any voting rights. The intent of such event of default provisions is to ultimately safeguard the company's interests by providing additional tools that the other shareholders and the company can leverage in an attempt to do damage control after a founder has gone rogue or committed fraud.

Approval thresholds

It is not uncommon for different shareholder reserved matters in a shareholders' agreement to have varying approval thresholds. For instance, some decisions may require a simple majority of preference shareholders, while others may necessitate a supermajority or unanimous consent from all shareholders. Additionally, specific groups of shareholders or individual shareholders with sufficient bargaining power may also have tailored reserved matters that are commercially significant to them. For example, approval from the Series A preference shareholders of a company has to be obtained before any alterations of or adverse amendments to the rights, preferences and privileges of the Series A preference shares are undertaken. This tailored approach ensures that the concerns of different investor groups are adequately addressed to the extent reasonably possible whilst not hindering the company in terms of operational efficiency, as only the consent of investor groups who are affected by such reserved matters is required.

As for board reserved matters, a common approval threshold is approval from a simple majority of the board and in some cases, a permutation of approval(s) from founder director(s) and/or investor director(s) is also required in addition. In situations where the founders and investors are of relatively equal bargaining positions, parties sometimes reach a negotiated position of requiring the approval from at least one founder director and one investor director. For companies with a broader base of investors, parties may also agree for board reserved matter approval to require a majority of all appointed investor directors to fairly account for each investor's director appointment rights which are in turn typically tied to the investors' shareholding percentages in the company.

Approval thresholds are not static and should evolve and adapt according to the funding life cycle of a company. In early-stage investments, it would not be uncommon for a lead investor to be able to unilaterally veto a range of matters. While founders would naturally want to ensure that reserved matter approvals are set at a threshold where no one shareholder or single investor director has a veto right and thus may hold the company hostage in the decision-making process, we have seen a few instances during the funding winter between 2023 and 2024 where early-stage lead investors were able to successfully negotiate for a fairly extensive list of unilateral veto rights given their relative strength in bargaining power. However, during later funding rounds with wider investor pools, parties would typically negotiate to agree to remove unilateral veto rights unless it is a point which is unique to that particular investor, for instance, approval in relation to an investment by a specific named competitor of such investor.

3. Examples of common reserved matters

Reserved matters cover a range of significant decisions affecting the company. While the specifics would vary from deal to deal as well as the stage of development of the company and the bargaining positions of the parties, some examples of common reserved matters include:

• Changes to share capitalisation or rights attached to shares: any alterations to the company's share structure, such as issuing new shares or amending the rights attached to existing shares, or any reduction, consolidation, subdivision or reclassification or other alteration in relation to the company's capital structure.
• Changes to business line: any change in the nature and/or scope of the business for the time being, extension of the scope of operations, entry into new lines of business or exit from existing lines of business.
• Mergers and acquisitions: any mergers, acquisitions, consolidations, reorganisations or spin-offs, or any sale or disposal of the whole or a substantial part of the undertaking or assets of the company.
• Changes to constitutive documents: any amendment to the constitutive documents of the company.
• Employment of C-suite officers: the appointment, terms of appointment (and amendment to such terms) or dismissal, of any C-suite officer, or other similar senior executive or officer of the company.
• Liquidation proceedings: the liquidation, dissolution or winding up of the company, and any other liquidity event defined in the constitutive documents to which the company is a party.
• Litigation proceedings: any commencement, withdrawal, defense or settlement by the company of any litigation or arbitration, administrative proceedings or legal actions.

4. Common qualifications to reserved matters

It is also common to negotiate for qualifications to the scope of reserved matters to ensure such matters are not overly restrictive or onerous, particularly where the day-to-day operations of the company may be obstructed. Some common qualifications include:

• Materiality thresholds: only matters that are agreed by the parties to be material enough should require the stated approvals, for example any purchase, acquisition, sale, transfer or disposal of any material undertaking, any material assets or any shares or other security interests by the company. What is deemed to be "material" is then a matter for parties to negotiate in the documents. This helps to flush out commercially salient matters.  
• "Ordinary Course of Business" carve-outs: routine decisions to be made in the ordinary course of business are typically excluded from reserved matters so as to not hinder operational efficiency.
• Amount thresholds: financial thresholds may be set for certain reserved matters; below which approval is not required, e.g., any incurrence by the company of any indebtedness in excess of a certain amount.
• Matters approved in the budget or business plan: decisions that have already been approved in the company's budget or business plan may be exempt from reserved matters, e.g., any exercise of the company's borrowing powers, other than borrowings approved in the annual budget.
• Minimum price floor: in the context of a trade sale or an initial public offering, reserved matter consent may not be required if a minimum price floor is met.

5. Practical considerations and conclusion

Looking beyond Singapore, we would note that generally, the lists of reserved matters tend to be longer and more restrictive on the company and the founders as compared to equivalent stockholders' agreements in the United States. This could very well be a reflection of the level of maturity of the markets and how there are fewer second or third-time founders in Southeast Asia as compared to Silicon Valley, though Southeast Asia is slowly but surely catching up with the growing numbers of serial entrepreneurs.

Evolution of reserved matters

Reserved matters evolve and respond to changes in the fundraising climate. For example, with 2023 onwards bringing a gradual shift in focus to environmental, social and governance (ESG) standards as performance indexes (in addition to the customary economic indicators) and the rise of impact investing, we have noticed an increase in requests from investors to include reserved matters in relation to decisions affecting the company's sustainability efforts, corporate social responsibility and compliance.

Additionally, the types of reserved matters would also have to be relooked from time to time to not only keep up with the latest trends, but to also account for fundraising-specific concerns. Between 2017 and 2021 when initial coin offerings were all the rage, it was important to ensure that new reserved matters were added to govern the sale, issuance, sponsorship, creation or distribution of any digital tokens, cryptocurrency or other blockchain-based assets, including through a pre-sale, initial coin offering, token distribution event or crowdfunding, or through the issuance of any instrument convertible into or exchangeable for such assets. The intent there was to ensure that there was no leakage of value from the company which was not subject to investor oversight. This is certainly not present in the "traditional" lists of reserved matters we may be used to seeing, and was a key reason for the introduction of this reserved matter in the first version of the Venture Capital Investment Model Agreements (VIMA) shareholders' agreement which was released in 2018.

Furthermore, given economic volatility and the rise and fall of fundraising optimism whether globally or in the region, investors naturally adopt a more capital-efficient mindset and gravitate towards having greater oversight over decisions that fundamentally impact their investments, such as share capital alterations or any merger, acquisition, consolidation, reorganisation or spin-off of the company.

Best practices in drafting

Bearing in mind the various considerations above, some best practices in drafting reserved matters include:

• Clarity in scope: having a clear, defined and unequivocal scope that reserved matters relate to can help avoid potential disputes in interpretation in the future. For example, instead of just stating "important debt-related matters", parties can consider specifying as examples the exact types of transactions that are intended to be covered, such as indebtedness, borrowings, mortgages, encumbrances or the exercise of the company's power to provide guarantees or indemnities.
• Specific qualifications: incorporating specific qualifications ensures that reserved matters are not overly restrictive. For example, only borrowings not otherwise approved in the annual budget and in excess of a particular amount shall require approval.
• Tailoring reserved matters to commercial needs: adapting reserved matters to the specific needs of different investor groups is one way to make sure that their concerns are adequately addressed while not overburdening the company to procure approvals from multiple stakeholders. Also just as important is to tailor the reserved matters to the company's size, nature of business and stage of development. The list of reserved matters for a very early-stage start-up company would almost certainly look quite different to that of a mature company which is heading towards an exit.
• Balancing control among stakeholders: having reasonably balanced control among various groups of stakeholders can help to maintain a collaborative and effective governance framework.

In conclusion, reserved matters should be thoughtfully drafted, taking into consideration the specific needs of the company and weighing the competing interests of its various stakeholders. Having a clear definition of which matters may be decided at what level should result in a calibrated and consistent approach to policy implementation. This is vital in establishing a robust governance framework. When done right, hopefully all decisions will then be unreservedly made in the best interests of the company.

About the authors:

Kyle Lee is the Co-Head of the WPGrow: Start-Up / Venture Capital Practice and a Partner in the Mergers & Acquisitions, and FinTech Practices at WongPartnership LLP. His main areas of practice encompass venture capital and start-up matters, local and international mergers and acquisitions, fintech, and general corporate and commercial transactions. Kyle is a member of the VIMA 2.0 working group.

Jolynn Lim is a Partner in the WPGrow: Start-Up / Venture Capital and Mergers & Acquisitions Practices at WongPartnership LLP. Her main practice areas are corporate mergers and acquisitions, start-up and venture capital matters, and general corporate and commercial transactions. Jolynn is a member of the VIMA 2.0 working group.

Wira Hakim Isa is a Senior Associate in the WPGrow: Start-Up / Venture Capital and Mergers & Acquisitions Practices at WongPartnership LLP. His practice focuses on corporate transactions including single and multi-jurisdictional mergers & acquisitions, private equity, venture capital and start-up matters, joint ventures, and corporate restructuring exercises.

Disclaimer: This article is intended for general information only. It is not intended to be, nor should it be, regarded as or relied upon as legal advice. Readers should consult qualified legal professionals before taking any action or omitting to take action in relation to matters discussed herein. This article does not create an attorney-client relationship and is not attorney advertising. Neither the Singapore Academy of Law nor any of the VIMA 2.0 working group members or contributors takes any responsibility for the contents of this article.

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