Making an investment, whether in a private equity fund, startup company, or other asset, can lead to legal issues down the road. Understanding the potential legal risks involved is crucial for any investor. Some common legal issues that can arise post-investment include disputes over valuation and ownership percentages, lawsuits related to misrepresentation or fraud, liability concerns, and issues with company governance and decision-making. Proper due diligence and carefully crafted legal agreements are important prevention measures. However, even experienced investors can encounter messy lawsuits and other legal challenges. Being aware of the legal landscape and working with qualified investment counsel can help investors navigate any post-investment disputes.
Valuation and ownership disputes stemming from ambiguous or flawed agreements
One of the most common legal issues investors face is disputes over valuation and ownership stakes, especially for private company investments. Often, early agreements fail to clearly spell out details like share classes, liquidation preferences, anti-dilution provisions, and other terms. As a company grows and raises more funding rounds, these gray areas lead to different interpretations of who owns what. Lawsuits can emerge as founders and investors fight over the true valuation and distribution of equity. Using detailed Stock Purchase Agreements and Shareholder Agreements, with clearly defined terms, can help prevent many disputes.
Lawsuits over misrepresentation, inadequate disclosures, and fraud
Investors who feel a deal was based on incomplete or purposely false information may sue company founders and management over misrepresentation and fraud. For example, a biotech startup founder might exaggerate the status of a drug pipeline or regulatory approval. Or, a company pitch deck could present inflated growth and financials numbers. If investors later learn they were duped, legal action can follow. Founders should be vigilant about truthfully representing their company’s condition. Investors should also conduct detailed due diligence before finalizing a deal.
Liability concerns and investor lawsuits
After investing in a company, investors may face legal liability for the company’s actions. In certain cases, company debts and other obligations can extend to major shareholders and board members. Lawsuits targeting investors directly can also occur, like with pension fund plaintiffs who sued private equity firms over buyout deals. Liability insurance and legal entity structuring can provide some protection. But there are still scenarios where investors get embroiled in legal action due to a company’s missteps.
Disputes over company governance and decision-making
Tensions frequently emerge between founders and investors related to company governance and strategy. Board seats granted to investors often come with expectations of having a voice in major decisions. But founders can resist perceived investor overreach. These conflicts boil over into lawsuits in some cases. Clear voting rights and board member agreements are important. But human relationships and clashing priorities also impact governance disputes.
From valuation ambiguities to fraud allegations, investors must navigate a range of potential legal issues post-investment. Careful planning and agreements provide some safeguards. However, legal disputes and surprises still occur. Having competent investment legal counsel as part of your team can help investors anticipate and respond to any post-investment litigation or conflict.