Having found an investor proposing 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
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 (like many other in service industries) tend to base their
charges upon the amount of time which they spend considering and
advising upon matters that they are consulted in relation to.
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 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 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
generally be drafted on a 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).
Generally, the investment documentation will 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
(Click here for a Copy).
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. If you would
like to discuss matters further, please do not hesitate to contact the
writer so as to do so.
