Recently, at Techstars, we’re noticing more and more that we are being asked to sign up for joint unlimited liability for fraud in the context of M&A with one of our portfolio companies. In other words, we are being asked to guarantee that our portfolio companies, and sometimes even that other shareholders of these companies, have not committed fraud. That is not acceptable. We are willing to sign up for unlimited liability only if it’s because of our own fraud.
Why is this such an issue? Unlimited liability means that Techstars could potentially be liable for more than the entire proceeds of the deal. In a worst case scenario it could be materially damaging to our business as a whole and the other companies we support. Therefore, we will only sign up to our own fraud (several liability), as we are only able to guarantee that we are good actors, not everyone around the table.
We think it is bad behavior for acquirers to ask for this, and investors should not sign up for joint unlimited liability for fraud. This is especially true when those investors did not serve on the board of directors or in any type of active or control position.
On the other hand, investors should be willing to sign up for unlimited liability for their own fraud. Fair is fair.
As a seed investor who is not always on the board of our companies, we often we receive these agreements once the deal is already closing, and the required majority have consented. This is very disappointing to us, because we no longer have leverage to make this important change. At this point we are given the choice to sign an egregious agreement or not get a return on our investment. If investors negotiating a deal are not keeping other investors in the loop, the minimum they should ensure is that all liabilities are capped at deal proceeds and should be several to the maximum extent possible.
I hope this post helps acquirers understand that they should not ask for joint unlimited liability from financial investors who are not in control positions. I also hope it encourages other investors not to sign up for joint unlimited liability for the fraud of their portfolio companies or the other shareholders.
I’d love to hear about any of your own experiences with this in the comments!