Having found a business angel or venture capitalist wanting to invest in your business, your attention needs to turn to the documentation that you are likely to need to reflect your agreement. Firstly – Make sure that you have a clear understanding of the outline terms of investment (prepare a non-legally binding ‘Heads’ or ‘Term(s) Sheet’ – that you both agree with).
At the very least, your investor is going to want to see that their ownership interest (in shares) is properly documented as issued in the investor’s name. This (in itself) involves a certain amount of paperwork- although it is not unheard of for an investor to subscribe to shares merely on the basis of the broadly standard constitution of an English limited liability company (i.e. the Companies Act’s – ‘Model Articles of Association’).
However, if your investor is to hold a minority stake, and/or not be ‘hands-on’ (i.e. actively involved on a frequent basis) with the company in which they are investing, it is likely that they will seek some element of agreed investment documentation to protect their interests. As a founder of the business – you want their money, such that you may find yourself presented with a ‘take it or leave it’ proposition. The worst thing you can do in such a situation – is simply accept the terms on offer, particularly if you are not to consider them in any detail (with the aim of seeking to know what you are agreeing to).
Budgeted investment contract review
The problem is that in early-stage / venture capital type investment transactions, the sums of money being invested are generally quite modest and do not leave much of a budget for legal advice and legal costs on the proposed investment contracts.
Accordingly, an investor’s initial position is generally to resist the founders taking legal advice on investment documentation – largely because it is the investor’s money which directly or indirectly is likely to be paying the legal fees. However, as a founder you should seek to persuade the investor that such an attitude is counter-productive, and that it is much better for you to gain a full understanding of (and agree to) the detail of the investment documentation you are proposing entering into – if a sound on-going relationship is to be created between you.
Lawyers tend to base their charges on the amount of time which they spend considering and advising upon matters that they are consulted about. Experienced lawyers should be able to agree with you an (estimated or) budgeted fee for work to be undertaken (in light of what interested parties consider to be sensible for the work).
Having set your budget for legal review, make sure that you get the maximum value out of the legal advice you receive. For example, if your budget only buys a limited amount of time from your legal adviser, make sure that they take you through the documentation (on a ‘page turn’ basis) so that you fully understand the terms which you are being asked to agree to.
A good adviser should know and have seen the format of such documentation before, know what is reasonable market practice (and what is not), and know the issues which need to be explained to you. If there are any commercial/legal terms which you have an objection to, often the most effective way to resolve the issues is to discuss matters directly between the founder and the investor – with the hope that a compromise position can be found.
As a founder, you need to be aware that an investor has a range of legitimate protections that they will reasonably require in the documentation (e.g. that their likely minority position will not be abused by your continuing majority control of the company in which they are investing).
Certain other provisions might seem unfair to you at first glance, but with appropriate revisions and careful drafting, you may well be able to accept them. Falling into this class of provisions might be the well-known “leaver provisions”, whereby if a founder were to leave the company at some point in the future, your shares become capable of re-acquisition by the company, etc. The investor will want to know that you will continue to be actively involved in the business – thereby protecting their investment on an on-going basis. If you cease to be involved in the business in the future, it is arguably fair that you should potentially receive the value which you have created to that point in time, but arguably not that you should be able to continue as a ‘sleeping partner’ in the business.
Having accepted that the investor may well have legitimate reasons for wanting appropriate documentation, interested parties should then aim for the documentation to be drafted and settled efficiently and cost effectively. Legal documentation (in the writer’s opinion) should be drafted on the basis of being fair and reasonable.
Generally, the investor’s lawyers will prepare the documentation (although it is possible for the company to give instructions for the lawyers to prepare what is intended to be market practice documentation – which is intended to assist with the taking of investment, and which are designed to be sensible even-handed documents between the parties).
The investment documentation will usually comprise (i) articles of association and (ii) an agreement (often variously described by a combination of the words ‘investment’, ‘subscription’ and/or ‘shareholders’ agreement).
Articles of association
Every company has articles of association – often comprising the Companies Act’s ‘Model Articles’ (with small amendments), which are generally adopted by default upon incorporation. Articles of association can be considered as akin to a ‘club constitution’ – legally comprising a binding agreement between the company and the shareholders from time to time. Such a document can be quite impenetrable to a layman – and largely for this reason, in certain early-stage investments, specifically drafted articles of association are not prepared.
However, if new articles or revisions to the articles of being proposed, you should treat this document as the primary document which you first review. Lack of familiarity with articles often means that people choose not to read that document – and for this reason (and the reason that certain share-based rights are more easily enforced through the articles of association) – many of the more onerous provisions in investment arrangements are often included in the articles.
Subscription and shareholders agreement
The other document which is generally utilised as part of the investment arrangements is a separate written agreement – generally a much more accessible document (for those who deal with the same) – and prepared in the format of a private agreement between the founder and the investor (generally with the company also a party).
Model documentation
The internet has assisted such arrangements in many ways, including the fact that early-stage venture capitalists – and others active in the market – now have easy access to basic documentation which is considered to be market standard. One example of this is the early-stage venture capital documentation produced by the British Venture Capital Association (BVCA) and which is widely available on the internet.
Before you enter into investment contracts and arrangements, it may be useful for you to try and review the articles and the investment agreement at the link above, so that you can understand the type of arrangements which you may be subject to. Please note however that the documentation set out above is quite detailed and complicated, and there are a number of less accessible but nevertheless widely recognised documentation (often based upon the above documents) that lawyers can easily gain access to.
Use of standard (or recognised) documents greatly assists with a rapid and efficient investment, and hence – one drafting approach is to ensure that a particular set of model documentation is used in preparing drafts and then reviewed by lawyers (with the amendments proposed made to the standard documentation clearly show). This removes a lot of time from the consideration process so that the detail can be focused upon by those who review the documentation.
The above review only “scratches the surface” of the subject – but we hope that it gives you an understanding of the process and documentation you are likely to need to be subject to.