Risk Sharing in Investment Contracts for Artificial Intelligence Startups

Entrance

Artificial intelligence (AI) startups are among the sectors attracting the most investor interest due to their high growth potential and scalable business models. However, these startups:

Technological risk (technical failure of the product),
Legal risks (intellectual property infringements, regulations),
Commercial risk (the market not growing as expected),
It carries multifaceted risks, including ethical and social risks (algorithmic bias, data breach)

Therefore, investment agreements for AI startups should include more detailed risk-sharing mechanisms than traditional startup contracts .

1. Types of Risks in Investment Contracts

1.1. Technological Risk

The algorithm failed to achieve the expected level of accuracy.
Development costs exceeded estimates.
Regulation-related technical adaptation requirements (e.g., EU Artificial Intelligence Law).

1.2. Legal Risk

Infringement of intellectual property rights (patents, database rights).
Lack of compliance with KVKK and GDPR.
Invalidity of third-party data licenses.

1.3. Commercial Risk

Failure to enter the target market.
The need for a business model change (pivot).
The emergence of competitive technologies.

2. Risk Sharing Mechanisms

2.1. Tranche Funding

The investment is not released all at once, but rather as specific performance targets are achieved
Example: "A second tranche investment is made when the model's accuracy rate reaches 90%."

2.2. Convertible Note

The initial investment is made in the form of debt; if certain conditions are met, it is converted into shares.
In AI startups, investors may be reluctant to acquire a stake before the technology validation is complete.

2.3. Ratchet Clauses (Participation Rate Adjustment)

If revenue or profitability targets are not met, investor share automatically increases.
Full Ratchet: The investor's share price will not fall in the next low-valuation investment round.
Weighted Average Ratchet: Allows for a more balanced share adjustment.

2.4. Warranties & Indemnities

The founders guarantee that the intellectual property belongs entirely to the company.
In case of breach, for damages and/or share buyback will arise.

📌 Supreme Court 11th Civil Chamber, Case No. 2019/2321, Decision No. 2021/3142: Violation of a matter explicitly guaranteed in an investment contract gives rise to liability for compensation.

3. Additional Risk Factors Specific to the Artificial Intelligence Sector

Data Source Risk
- The training data used must not contain any copyright or data protection infringements.
Ethical and Regulatory Risks
- Algorithmic discrimination, liability for damages resulting from erroneous predictions.
Model Update and Maintenance Obligation
- The founding team is responsible for bug fixes and updates after the product is released.
The Risks of Using Open Source Code
- Compliance with GPL, MIT, and Apache licenses; otherwise, there are legal risks.

4. Risk Management in Exit Strategies

Drag-along & Tag-along Rights: Protection of investors' shares upon exit.
Pre-IPO or Company Sale Intellectual Property Rights Clearance: Ensuring all intellectual property is registered in the company's name.
Non-competitive: The founders are prohibited from participating in competing AI projects.

5. International Case Studies

USA (Silicon Valley): Investors in AI startups set "Technology Validation Milestones" as a requirement.
EU: Until compliance with the AI Act is achieved, a portion of the investments will be held in an escrow account.
Turkey: Especially in technopark ventures, investors look for compliance requirements with TÜBİTAK and KOSGEB projects.

6. Conclusion

Artificial intelligence startups, despite their high potential, high-risk investments. Therefore, investment contracts:

Performance-based investment,
Share ratio adjustments,
Warranty and indemnity provisions,
data and intellectual property safeguards
.

From the investor's perspective, these provisions to protect capital; from the entrepreneur's perspective, preserve the freedom to develop . This balance ensures both the continuation of the investment and the sustainability of the venture.

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