[Startup Must-Know Laws] Effectiveness of IPO Obligation Clauses in Investment Agreements

Startup Legal Essentials by Heecheol Ahn

Attorney Heecheol Ahn

When unlisted startups enter into investment agreements, an IPO obligation clause is almost invariably included. However, two recent rulings by the Seoul Central District Court and the Seoul High Court interpreted the legal nature of this IPO obligation not as an obligation to achieve a specific result, but as an obligation to make best efforts. In other words, the investee company is not required to guarantee an IPO, but rather to make its best efforts to pursue an IPO in accordance with the duty of care expected of a prudent manager.

An IPO is not a procedure that occurs automatically upon meeting certain conditions; instead, the outcome is uncertain and depends on various factors such as review by the Korea Exchange, accounting audits, market outlook, and investor relations activities. In the actual case, the investee company recorded operating losses for four consecutive years, and the market conditions deteriorated during the COVID-19 pandemic, which hindered the IPO process. The court recognized these circumstances and determined that the mere fact that an IPO did not occur could not, by itself, be considered a breach of contract.

Investment agreements often include a damages clause requiring the full return of investment funds if the IPO fails, but the court also ruled such clauses invalid. The reason is that a structure that allocates reserved profits to specific investors in priority, regardless of IPO failure, seriously undermines fairness among shareholders. This violates the principle of shareholder equality under commercial law. In essence, it provides an absolute guarantee of recovery to certain shareholders, which is contrary to the principle of shareholder equality.

The fact that the court views the IPO obligation as a best-efforts obligation and the damages clause as a violation of shareholder equality does not mean that investors are left without protection. In recent cases, courts have found that including a “conditional put option” clause is valid. Both the Seoul Central District Court and the Seoul High Court ruled that if an IPO is not completed by the deadline specified in the investment agreement, the investor may exercise a put option, allowing them to sell their shares to the investee company or related parties (such as shareholders or the CEO).

The IPO obligation clause in startup investment agreements is not merely a legal provision, but rather a matter of balancing the investor’s exit strategy and the responsibilities of the investee company. These rulings illustrate how courts interpret such clauses and suggest that they should be understood not as clauses guaranteeing a specific result, but as clauses requiring best efforts.