Well, first things, first – congratulations! All that hard graft has finally paid off and you have someone who thinks you have a business worth building. Bask in that glow! Now back down to reality: it’s no longer just you and your partner’s money and time involved – now, the hard(er) work begins!
Generally, most investors will make sure that they and their lawyers will hold the pen in terms of the drafting of the investment agreement. It would be a rare situation where you would have full autonomy over the drafting of the agreement (or your lawyer for that matter).
Therefore, it will be important that you understand the legal provisions (and their repercussions) that are common in such an agreement. It will at least put you on better negotiating terms and you can go into the agreement with your eyes wide open.
Obviously, I’d highly suggest hiring a lawyer at this point, especially if the investment is for a significant amount of money; they are experts and you need to focus on the business. As an aside, there is a growing trend for ‘plain English’ drafting – that is, removing a lot of the legalese from start-up legal documentation.
We are great supporters of this trend and we think this is a good step in the democratisation of the law and making it accessible for everyone, like we’re seeing with, the popularity of crowd funding.
Yet there are serious pitfalls: recently we’ve seen a start-up where the ‘plain English’ terms applied only to what the start-up had to do (whose terms were quite onerous), but very flaky English terms for what the investor had to do. ‘Would be willing’ is not an easier word to understand compared to ‘shall’; so be careful.
Investment Agreement Amuse-Bouche
The following would be important concepts to understand when approaching any investment agreement.
Grant of Rights
Make sure the investor is obligated to invest their money, it will be very likely that there is reciprocal obligation on your company to issue shares to the investor. This sounds basic, but some drafting tries to hold the investment back in vague terms. See my point above, between, ‘willing to’ and ‘shall’. It’s fine if some events need to occur before the money is released, we call these;
Conditions Precedent
These are certain events which must occur or be in existence before the investor will release the funds (e.g. obtaining a patent, no insolvency, hiring of some employee etc.). If you are a start-up, you want to ensure these are as limited as possible.
It will be near impossible to eliminate all, as an investor wants to ensure that say, the company has authorised the directors to issue more shares for the new investor; it would be silly from the Investor’s point of view to release the money, yet the directors not have made available the shares in question.
What might be onerous on you and your company, will vary in the circumstances and will depend on your bargaining power with the investor. Be careful what conditions precedent you are signing up to, consider them hurdles to your much needed influx of capital.
Warranties
At its basest form, a warranty is a statement in a contract which promises something to the other party. This promise typically relates to the state of affairs of the company which is taking on the investment. If the promise is breached, the party to whom the promise was made quite possibly could claim for damages if it has suffered loss as a result of the breach of the warranty.
It is essential that you understand what warranties you are making about you and your company and that they are true at the time they are made. Make them as specific as possible, so that you are not on the hook for a range of things. Some common warranties found in investment agreements:
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All of the shares are fully paid and comprise the entire issued share capital of your company – none of the shares are subject to charges, options, or other types of encumbrances;
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That your business plan has been prepared diligently and it is a genuine plan for the future;
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There is nothing false in your management accounts;
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You own all of the intellectual property which you use, none of it is encumbered and/or you have all the appropriate licences in place to use the intellectual property; and
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No one has any litigation or claims against you.
These are just but a few examples of the subject matter warranties try to address, so that your investor has a better picture of the company they’re investing in. Warranties are heavily negotiated and this is where your solicitor can make a difference. Your solicitor will also end up preparing what is known as a disclosure letter which acts as the counter-point to the warranties.
For example, you warrant that no one is suing the company, but, there is that one small lawsuit that exists – that will go in the disclosure letter. This will ensure that the warranty remains true, save as disclosed to the investor in the letter; it acts as a protection for you as a warrantor against future claims. It is best to disclose everything material against the warranties, do not hide anything if you think a warranty is untrue, inaccurate or misleading without the disclosure.
This is a taster of what (hopefully) is coming your way when you take on new and amazing investors. It also highlights that this is a very complex agreement with a number of moving parts, therefore, it is prudent to have a lawyer look at the documentation at this juncture. Certain provisions you might just have to live with because of bargaining power, but you could end up living with the bargain for a long time. If it is a bad one, you might wish you had read more Tech City News.