Protective Provisions

Protective provisions are one of the special rights negotiated by investors participating in a company’s preferred stock financing. Protective provisions give preferred stockholders in a company consent rights with respect to key corporate actions the company seeks to take. The company will typically outline its protective provisions for investors in a series of clauses in its charter, which is the company’s central governing document. Examples of commonly negotiated protective provisions held by preferred stockholders include consent rights concerning the company’s ability to approve:

  • Amending its charter;
  • Creating a new class or series of capital stock, in particular when such new class or series ranks senior to or on parity with the existing preferred stock in liquidation preference, payment of dividends and redemption rights;
  • Incurring debt outside the ordinary course of business;
  • A merger or sale of substantially all of the assets of the company; or
  • Increasing or decreasing the size of the board of directors.

While this is a non-exhaustive list, it provides an idea of what types of actions are subject to approval by investors following a typical growth financing. This segment of an impact investing transaction can be critical in an entrepreneur’s efforts to commit and stay true to their mission-driven business.

Why are protective provisions important to entrepreneurs?

Protective provisions are one component of a system of checks and balances built into investment documents to allow investors to ensure that the company is meeting business expectations related to the capital being provided. However, the process of negotiating and finalizing investor consent rights enshrined in the protective provisions can also be helpful for entrepreneurs. Founders can gain important insight into the priorities and strategic direction that investors have in mind when deciding to provide capital to the business by understanding which business decisions such investors push to have greater authority over.

Striking a balance in the alignment of economic interests between founders and investors is not always easy. However, spending time carefully curating this balance between the rights of founders versus investors can make for a successful company that stays true to the founder’s foundational vision, while also benefiting from the identification of market need and other guidance and know-how investors can provide. By understanding an investors’ priorities vis-à-vis the approval rights that are central to their negotiation, founders can draw the knowledge needed to build leverage on their end of the table. Entrepreneurs should also keep this insight in mind in order to measure an investors’ priorities against their own, and to evaluate where to give and where to take in accepting outside capital.

As a company goes through multiple rounds of financing, founders and management should also be cognizant of the different consent rights granted from one financing to the next to ensure that no investor holds consent rights disproportionate to their position in the company. In the end, it is less controversial to build on the protective provisions granted to earlier investors than it is to attempt to revoke the rights granted to earlier investors in order to keep all investors on a level playing field.

In particular, a consent right which is granted to all preferred stockholders voting as a single class can turn into a veto right where one series of preferred stockholders hold a majority of all of the preferred stock outstanding. While there may be merit to this structure based on the size and pricing of different financing rounds within a single company, a company may calculate to instead negotiate different protective provisions for each series of preferred stockholders voting separately as a class to avoid a veto right down the line. In this way, a founder’s working knowledge of market protective provisions and awareness of existing rights within his or her own company is crucial to scaling and growing without swinging the pendulum too far in favor of any one investor group.

Ultimately, protective provisions can play a key role in promoting good governance and accountability as a company grows its business and builds upon its shareholder base. Our series on protective provisions will explore how different investor consent rights can be negotiated by impact entrepreneurs in order to communicate their commitment to a company’s mission and to find investors aligned with that commitment. An understanding of how protective provisions fit into the negotiation of a financing will allow entrepreneurs to maintain a balance among the decision-making authority of founders, investors and other stakeholders in an impact company.

Additional Resources

  • Daniel DeWolf, What is a Term Sheet?, MintzEDGE,
  • Daniel DeWolf et al., Corporate Formation: The Basics, MintzEDGE (March 11, 2016),

Steward Ownership

Steward-ownership refers to a set of legal structures that instill two core principles into the legal DNA of a business: self-governance and profits serve purpose. These structures ensure that control (voting rights) over the business is held by people inside the organization or very closely connected to its mission. Voting control in steward-ownership forms is not a saleable commodity. Profits in steward-ownership are understood as a tool for pursuing the company’s purpose. After paying back capital providers and sharing economic upside with stakeholders, the majority of profits are reinvested in the business. Steward-ownership forms include an asset-lock, which prevents the proceeds from a sale from being privatized.  This structure aligns decision making power with active stakeholders close to the business, instead of remote investors or shareholders

For a more detailed discussion of Steward Ownership, listen to this discussion with Camille Canon of Purpose Foundation

Principles of Steward Ownership

Purpose, an organization dedicated to promoting and supporting steward ownership, outlines two critical attributes of steward ownership:

  1. Governance is executed by stakeholders directly involved in running the company or directly connected to it, rather than by investors or outside influences.
  2. Profits are primarily reinvested or donated towards advancing the company‘s purpose.

Benefits of Steward Ownership

The principles of steward ownership dictate that the “steward-owners” be those who have the best interests of the company at heart. Since these steward-owners prioritize purpose over financial performance, these companies are more long-term oriented and studies show that their survival probability is 6X higher after 40 years. Research by Professor Steen Thomsen, chairman of the Center for Corporate Governance at Copenhagen Business School, shows that companies with ownership structures like this are trusted more by their customers, offer their employees better pay, and have better employee retention. 

Legal Structure

Currently, there is no one-size-fits-all legal entity for companies pursuing steward ownership; structures vary among legal jurisdictions and companies. Despite legal differences, uniting threads between them are that stewards must pass voting rights onto successors upon leaving their role and must be committed to protecting the company’s purpose and mission over time.

Legal structure examples summarized from content in this booklet from Purpose

Sample Term 1 – Steward Ownership

Download a sample summary and term sheet that represents an overview of a private offering to purchase Series A non-voting preferred stock in a company.

Background and Case Studies 

There is a strong history of steward-ownership in Denmark, the Netherlands, and Germany.  Zeiss, the German optics manufacturing company, is one of the first examples of a modern steward-owned company, which has been in operation for over 100 years. Zeiss, transitioned to steward ownership after the passing of its founder, Carl Zeiss. The Carl Zeiss Foundation is the sole owner of Zeiss, and its corporate constitution ensures that the company cannot be sold and profits are either reinvested or donated for the common good. 

Over the years, hundreds of steward-owned companies of various sizes and structures have been incorporated. Well-known examples include Bosch, Novo Nordisk, John Lewis department stores, and Mozilla. 

Organically Grown Company, a leader in sustainable and organic agriculture in the United States for over 40 years, transitioned to an alternative ownership structure in the form a Perpetual Purpose Trust in 2018. Download the full case study:

Further Resources

Pay For Success

Pay For Success is a public-private partnership in which a non-government funder pays the up-front costs for a social service intervention and is repaid by a government actor based on the achievement of previously agreed-upon target outcomes

The term “pay for success” (“PFS” in shorthand) is most commonly used in the United States. The concept originated in the United Kingdom under the name “social impact bond.” When the concept was introduced in the United States, the name “pay for success” was adopted because not all projects are formulated with a traditional bond structure. In emerging markets, the term “development impact bond” has emerged to describe this concept in an international development context. 


The principle characteristics of a Pay For Success project are as follows:

  • A focus on outcomes, rather than outputs. Payments are made based on the outcomes experienced by the people served by the social service intervention, rather than the number of people served. This is a structural shift from how most social services are funded. 
  • Up-front funding by a non-government funder: The social service intervention is paid for by a private investor, philanthropy, or other non-government funder, who can expect to be repaid only if target outcomes are achieved. If the project is unsuccessful — and the target outcomes are not achieved — then that non-government funder is not repaid for the investment. Therefore, taxpayers are not responsible for paying for an intervention that did not work as planned. 


The concept was originated by Sir Ronald Cohen in the UK.

The first social impact bond was implemented at Peterborough Prison near York, UK. In that project, a private investor paid for people who were preparing to be released from prison but deemed to be at a higher risk for re-offending to participate in a new recidivism diversion program. The UK government agreed to repay the investor if recidivism among the participants was reduced by a targeted percentage. The project launched in 2010 and concluded in 2015, with findings that showed a reduction in reoffending. Results:

In 2010, the US federal government under President Barack Obama began adapting the concept for use by state and local grantees of federal funding from the US Departments of Labor, Education, and Justice. This work was centralized under the White House Domestic Policy Council’s Office of Social Innovation and Civic Participation. The first projects in the US launched in 2012.


Each pay for success project or initiative has the following actors participating:

  • Government actor: A government agency is responsible for paying for outcomes upon achievement, based on terms agreed upon by all parties in the project negotiation. Repayment is generally expected to be consistent with the money the government is saving due to the intervention. For example, a reduction in the number of formerly incarcerated people reoffending leads, in theory, to fewer prisoners that the government must support. 
  • Service provider: The social service intervention is provided by a non-profit or for-profit organization. The service provider contracts with the non-government actor making the up-front investment, so they are paid for delivering the intervention regardless of impact. Typically, the service provider is selected by the investor, with review or approval from the government, through a competitive process and must demonstrate expertise or a track record of success in delivering the service to the target population. 
  • Non-government funder: A non-government funder pays the upfront costs of the service provider to deliver the social service intervention to the target population. This non-government actor is often a private investor, but could also be a philanthropy, community foundation, high net worth individual, or other funder. If the social service intervention reaches agreed-upon outcomes, the actor is repaid. If not, the actor is expected to take the loss. 
  • Evaluator: An independent evaluator is contracted to perform an independent evaluation of the social service intervention provided to the target population, to determine whether agreed-upon outcomes were met. The rigor of the evaluation, including the use of a control group, is determined by the parties involved. 
  • Intermediary organization: Most PFS projects have an intermediary organization that serves a mediation and management role. This organization brings the parties together to create the project and agree on the target outcomes to be achieved. The work of the intermediary organization is often funded by philanthropic donations. 



Overview of valid critiques of the model —

  • Concern that PFS would siphon money from existing social programs and/or private them has not come to fruition. Model is intended to validate/test whether a new service/intervention is more effective then status quo — governments may or may not end up using that information
  • Evaluations: An independent evaluation is a core part of a pay for success project. The expectations for the rigor of that evaluation have been debated, particularly in the wake of Urban Institute and other early field leaders have argued that PFS project evaluations should be randomized control trials (RCTs) unless there is a compelling reason to use a less rigorous method. 
  • Scalability: Since the launch of the first pay for success projects, a major critique of the model has been the cost of putting projects together. Philanthropic grants are generally still required to fund the 18-to-24-month process.  
  • Concern that governments will not scale successful projects – too early to tell
  • Capacity building for nonprofits

Case Studies

In 2015, India pioneered the world’s first development impact bond (DIB) where the outcome payer was a private foundation. Read more in the following case study from AVPN:

Additional Resources



Revenue Based Financing

Revenue Based Financing is the most popular form of contingent payment structures and is often used as an alternative exit structure.

Revenue Based Financing structures are contingent payment instruments that dedicated a percentage of revenues as the source of returns to investors.  The structures are typically designed to stop paying investors when the investor has received the negotiated target return. Typically, that negotiated return is expressed as a multiple of the initial investment.  For example, investors seeking a 3X return target that has invested $100,000 would receive their share of revenues until the investor has been paid $100,000 X 3 = $300,000. It’s important to note that the investors return on capital will depend on the timing of the payments – and thus will depend on the rate of revenue growth.   The same 3x return target will have a much better return on capital if the company has fast revenue growth compared to the same company if it experiences slower revenue growth.

Revenue Based Financing can either be set up as debt or equity structures depending on the local laws.  When using equity they are typically Redemption Based Exits in that the issuer is obligated to repurchase the equity from the investor at a specified premium.  In Revenue Based exit Structured as debt, the payments to the investor are treated as a mix of interest and principal payments.

Key Considerations for Deal Structuring

Legal and Accounting Considerations


Complexity is an important consideration when seeking the most appropriate capital for a company.  If the needs for capital are appropriately met with traditional structures then using traditional structures will likely reduce transaction costs and investor reticence.

Many of the alternative exit structures are new, are not well understood by many practitioners, and have less clarity about their tax, accounting, and legal merits than traditional exits.  These complexities can add costs and slow the transaction process.

Equity vs Debt

It’s important to understand that just because a security is labeled as “equity” or “debt” does not mean that the local tax authorities will accept that label.  It is common for tax authorities to have procedures to reclassify securities based on their economic structures.  Any reclassification could significantly change the economics of the security and/or increase the difficulty of accounting and other compliance elements.

We recommend any investor or entrepreneur seeking to use an alternate exit structure seek professional advice on the tax implications with a specific focus on reclassification risk.

Usury Laws

When an alternative exit uses a debt structure or a structure that could be reclassified as debt issuers must be careful that the nature of the contingent payments don’t violate local usury laws.  Usury laws are laws that set a maximum interest rate on debt payments.

What is interest vs principal?

When an issuer pays an investor some return on a debt structure it needs to be clear to both parties what portion of the payment is interest and what portion is principal.  This distinction is important because generally the return of principal is not taxed but the interest is subject to taxation.

Traditional investment structures calculate the principal and interest portions of a payment using near-universally accepted amortization tables.  With many alternative exit debt structures it is not clear how to create an amortization table that is accepted by the local tax authorities.

For example, consider a debt based alternative exit where the source of returns is a fixed percentage of revenues until the investor receives 3 (three) times their initial investment (a revenue based contingent payment).  If the investor invested $100,000 then when the transaction has completed its duration the investor will have received $300,000 in payments of which $100,000 has to be treated as return of principle and $200,000 has to be treated as interest..  If the first payment is $10,000 – what portion of that is principal and what is interest?  It might make sense to call ⅓ principal and ⅔ interest.  It also might make sense to call the entire $100,000 of payments principal and then all the rest interest.

While it is possible that your local tax jurisdiction will not have clear rules, it is more likely that they do have rules for properly apportioning principle and interest because not having those rules would have made it easy for investors to take advantage of their absence and create investment structures that are intended to delay, defer or avoid taxes.

Complicated accounting requirements

Some tax jurisdictions solve the above referenced question of apportioning interest and principle by imposing complicated tax accounting methods that can be burdensome to administer and may even create tax disadvantages to the investor.

For example, in the United States the law (26 CFR § 1.1275-4) requires contingent payment instruments to be treated as if they were not in fact contingent using the Noncontingent bond method. In addition to the added complication, this often has the negative consequence of requiring, in the early years of an investment, the investor to pay tax on income they will not receive until the later years of the investment. This article goes into more detail on taxes and revenue-based or other similar contingent payment instruments in the US – we highly recommend reading that article if you considering these structures in the US.

Distribution rules (eg re dividends and Board approval)

Local lay may have rules that need to be carefully considered when using equity instruments for alternative exits, especially when using a dividend as part of the structure.  Traditionally dividends may need to be authorized by the board and their may be restrictions on payment if the issuer does not have retained earnings.

Downside Protection

Traditional investment structures have clause for when the investment does not perform or when the company is forced to restructure or close.  The order in which creditors and investors get repaid in those cases is one of the negotiable features of term sheets but is generally based on the overall structure of the transaction with debt having higher preference than equity.  To the extent that an alternative exit has an economic structure that is different than its legal structure (eg a debt based exit that offers equity returns) the parties need to consider the appropriate downside protection.

Considerations by Legal Jurisdiction

The key questions that you need to ask to figure out what exit structures work in a given local legal system:

  • Do the tax authorities have rules for reclassifying debt as equity (or vice versa) – that is, is it possible that designing a debt instrument that pays variable payments (eg revenue based) would be reclassified as equity
    • if those rules exist you may need to create an equity structure
    • if those rules don’t exist then,
      • how are contingent payment debt securities taxed and accounted for.
        • how is each payment split between the return of principle vs interest? (need to know for investor and issuer – may not be the same)
        • are there rules that force contingent payment debt instruments to be accounted for in a way that may create phantom tax (in the US, for example, you have to act as if the payments were non contingent and create an amortization schedule and make tax payments based on that schedule – not just on what each payment ends up being)
    • Could designing an equity structure with mandatory redemptions be reclassified as debt
      • if yes this loops back to the questions re debt payments above
      • if no then equity with mandatory redemption contingent on (revenue %) is an easy option

Additional Resources

Blended Finance

What is Blended Finance?

Blended finance is the term used when public or philanthropic funds are used to catalyze private capital investment (particularly in frontier markets). It has been envisioned as a way to help bridge the funding gap to achieve the UN Sustainable Development Goals, leveraging public and philanthropic capital to bring more private capital to the development finance table. Typically, the public or philanthropic entities provide a type of concessionary and catalytic capital that lowers the risk profile of a particular investment for the commercial or private entity. This allows the entities to invest together while allowing different parties to define their measure of success. 

Blended finance is not limited to a specific transaction type, but instead is a structuring approach with three key characteristics: 

  • Impact, particularly in regards to the SDGs, is a motivating factor in the transaction
  • Financial returns are expected, although different parties may have different return expectations
  • Public or philanthropic capital is leveraged to act as a catalyst for the addition of private capital. 

How are blended finance deals structured? 

  • Grants – public/philanthropic partner gives money to support the project that has no expectation of being repaid. These funds can be used to support non-income generating activities or early stage preparations. 
  • Guarantees – public/philanthropic partner offers protection (often in the form of insurance) from capital loss. (lowers the risk or increases the credit rating)
  • Technical Assistance – public/philanthropic partner offers direct support to an entrepreneur, typically through a technical assistance facility or an incubator. 
  • Junior Equity – public/philanthropic partner buys ownership in the investment, but accepts a subordinate position in the structure, effectively accepting higher risk for lower returns. This structure is also sometimes referred to as concessional or first-loss capital. 
  • Flexible Debt – similar to junior equity, the public/philanthropic partner can accept subordinate terms to the debt structure, allowing for more favorable terms than the market offers. 

All of these strategies act to reduce the riskiness of an investment for private investors, thus leveraging the public or philanthropic funds provided to accomplish certain SDG goals. 

Chart from WEF/OECD

What are some examples of Blended Finance structures?

Convergence is a global network that was launched in 2016 to focus on blended finance. The organization maintains a database of blended finance transactions, including the following types, outlined in the table below:  

Transaction with concessional development fundingDevelopment agency invests concessional debt or junior equity into a fund, improving risk-adjusted return for private investors
Transaction with market rate public and private investmentPublic and private investors invest in a structure either pari passu or in
different tiers, but at pricing fully reflecting seniority, tenor and other
Grant-funded TA facility
alongside transaction
Commercial fund has associated grant-funded Technical Assistance
facility to build pipeline and support impact
Below market-rate risk miti- gation provided by
development funders
Development funders provide guarantee to bond issuance to improve
credit rating and attract private investment
Impact BondPrivate investors provide working capital for set of interventions and are repaid with a return by development funders if intervention achieves
pre-agreed results
Advance Market
Development funders guarantee a market for a product, incentivizing
private investment
Project Finance Facility Facility that only provides grant funding to infrastructure projects to reach bankability with the ultimate goal to attract private capital to projects;
underlying transactions considered blended
Transaction with grant funding for design and launchDevelopment funders provide grant funding for vehicle design and


Who is doing blended finance? 

According to Convergence and their data: “The most frequent private investors are asset/wealth managers and private equity/venture capital firms. The most frequent public investors are development finance institutions, governments, and multilateral groups. The most frequent philanthropic investors are private foundations.”

Further Resources

The GIIN’s Blended Finance Working group has published a helpful resource with key considerations and questions for stakeholders of blended finance deals:

More information about blended finance can be found at the following websites: