The share capital of a VC-backed company is generally divided in 2 types of shares: ordinary shares (‘Ords’) and preference shares (‘Prefs’). Ords are typically held by founders and (key) employees while Prefs are held by the VC investor (the ‘Investor’).

Prefs carry certain economic rights preferential to the rights of Ords such as a senior ranking entitlement to part of the proceeds upon a liquidity event of the company (i.e., not only a liquidation, but also an exit) (‘Liquidation Preference’) and AD Protection. AD Protection entitles the holder of Prefs to be compensated in case of a new investment round using a lower share price than paid by the Investor (‘Down Round’) by receiving additional Prefs.

Prefs are generally convertible into Ords, either automatically if certain criteria are met (e.g., to facilitate a transaction such as an IPO that is subject to simplifying the share capital) or voluntarily if elected by the Investor.

In the US, the Investor is usually compensated under AD Protection by adjusting the conversion ratio so that each Pref converts into more than 1 Ord. In the Netherlands an Investor is generally compensated by immediately (upon the Down Round) receiving new Prefs against par value which is typically settled without a cash payment.

The economic rights of an Investor in a Dutch company are sufficiently protected in both scenarios as an Investor generally has a so-called non-participating Liquidation Preference. This means that the Investor can elect to either receive a preferred amount (often capped at a multiple (usually 1x) of the initial investment in the Prefs) or, if higher, the amount it would receive if it would convert its Prefs into Ords on the basis of the conversion ratio adjusted due to the Down Round (‘Adjusted Conversion Ratio’).

However, the voting rights attached to the Investor’s Prefs are not sufficiently protected if the US practice is followed in respect of a Dutch company. The constitutional documents of a US target typically accommodate that the Investor can exercise rights (including voting rights) attached to its Prefs on an ‘as if converted basis’. Although Dutch law allows that the articles of association of the company cater for specific rules in respect of voting rights attached to shares, this US concept as such is not possible in the Netherlands. An Investor would typically only have additional voting rights upon converting the Prefs into Ords on the basis of the Adjusted Conversion Ratio (which it does not want before a liquidity event as Ords do not have a Liquidation Preference).

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