You have kickstarted a brand-new venture with your own money or seed investment from friends and family. Most other startups would have failed by now but your business model can prove its worth with your products and services. Your customer base keeps expanding and you will need more money and investments to grow.
It is rare for startups to be able to bootstrap and self-fund themselves, as most growth companies need to burn capital at a rate well beyond the financial capability of its founders, family and friends.
Developing business ideas and pioneering products is a fun thing to do, but the procedures of finding investors and raising capital may be long and complex. Founders tend to lose interest when it comes to the negotiation of capital raising documentation or investment agreement with investors. However, these documents are actually the most important as they can make or break your company.
Here is a beginner’s guide to the top capital raising documents and investment agreements for founders and entrepreneurs.
Capital raising allows startups to hire the right people, develop new products and services, conduct additional sales and marketing. This is particularly important for startups which do not generate enough cash flow for growth expansion.
There are two major ways to acquire financial capital, namely debt capital and equity capital. Debt capital is generated by borrowing money, while equity capital is generated by selling ownership of the company.
This article focuses on raising equity capital. Should you need to find debt-related documents, please refer to this Corporate Loan Agreement.
The perk of this capital raising method is the lack of financial burden as the founders do not have to pay the investor back. The investors receive financial returns based on the market performance of the company, usually in the form of the payment of dividends and stock valuation.
However, its major setback is that ownership of the company is diluted inevitably and business decisions would be accountable to other shareholders. Hence, the founders would have less flexibility in making risk-taking business development initiatives. That is why equity capital is generally considered to be more expensive than debt capital.
For successful startups, there may be several rounds of findings
Seed - usually friends and family or angel investors
Series A - usually Angel investors or Venture Capital funds
Series B - usually Venture Capital funds or Private Equity investors
Series C - usually Cornerstone investors or Private Equity investors looking to cash out on a future Initial Public Offering, IPO
These funding rounds allow investors with different investment appetites the opportunity to participate in different stages of the growth of the company through equity ownership.
Before raising capital though, make sure you establish your company properly. Here is The Guide to
Choosing the Best Structure for your Company. Check this out if you need help with getting your business started!
If you are looking to raise capital, let us get to the top 3 documents you may need!
An Investment Agreement is a contract between founders and investors who would like to purchase shares of an existing company. The incoming investor can be a new shareholder, an external investor or even an existing shareholder.
The Investment Agreement outlines the rights and responsibilities of the incoming shareholders, as well as imposing restrictions on the exercise of power. Terms and conditions are laid out clearly to the incoming company owners.
It is crucial for founders to raise capital by attracting investment from angel investors and investment companies. With a larger capital, they could accelerate business growth drastically by increasing business size.
Capital raising can be done by both private and public equity transactions. A public capital raising usually refers to companies that have already achieved Initial Public Offering (IPO) on the stock market. Stricter and more requirements are needed for a take-private (public to private, P2P) transaction.
For instance, the certainty of funds must be secured when a firm offer for a public company is announced. The conditions that give rise to its effectiveness and the rights to terminate it must not be unconditional, so as to comply with the requirements of a take-private investment transaction. In other words, the Investment Agreement needs to be limited.
As we are focusing on start-ups here, the following discussion assumes that the investment occurs in a private setting.
Here is a template of an Investment Agreement. Check it out for free!
Here are some questions to guide you through the drafting process of an Investment Agreement. Let’s get started!
The main term of an investment agreement involves the payment of a sum of money into the bank account of the company at a subscription price, by a certain time, on the completion date. Most of the time, the amount of the share capital corresponds to the issuance of shares by the company.
In other words, the more you pay, the more shares you get. The issue of shares will be recorded into a Company Record of Shares Transfer.
An Adherence Clause adheres obligations provided in the agreement to future transferees under the Investment Agreement. In addition, if there is a Shareholders’ Agreement in place between the shareholders, it is commonly executed by requiring the new investors or the transferee to enter into a deed of adherence to the Shareholders Agreement.
In other words, the rights and obligations of shareholders would remain the same after a transfer of shares, as if the new shareholder is an original investor bound by the Investment Agreement and/or Shareholders Agreement.
Sometimes, such clauses are incorporated by signing an additional deed, namely the Deed of Adherence. So, no worries if you forgot to include the adherence clause in your Investment Agreement.
Investment Trenches allow investors to pay their financial obligations in part payment. It is a form of “structured financing” which refers to the division of potentially risky financial products into loans. Under the Investment Agreement, fundings can be paid in instalments in stages over a period of time, known as trenches.
After agreeing to a partial payment of investment fundings, here comes the question: when should the investor pay the remaining fundings? A common practice is to pay according to the business milestones. Some common metrics include revenue, number of customers, product development, etc. Not only does this mitigate the risks undertaken by investors, but this also motivates founders to achieve their business goals!
In case the investor forgets to pay for the investment funding, don’t panic. Send a Call Notice to Shareholders to require them to make the payment under the Investment Agreement.
An Investment Warranty is an explicit representation that the statements made are true and accurate. The original owners of the company are required to warrant key corporate information, such as:
An Investment Warranty serves as an official legal document which gives rise to liability when the information warranted is untrue. It offers security to the incoming investor so that he/she would be more willing to fund the business!
If the company encounters certain business problems, the original owners should notify the incoming investors by a form of a Risk Disclosure Statement. Even if there are no business problems, the founder(s) may still want to issue a statement to assure the reliability and profitability of the investment.
Here are some common issues that the founders should indicate clearly to investors:
Litigation - that the current shareholders are not convicted by a criminal court or found by a civil court, or in any litigation proceedings, especially in violation of securities, commodities and trade practices laws
Financial status - that the current shareholders are not subject to bankruptcy
Conflicting relationships - that the current shareholders have no confidentiality agreements or orders that prevent them from managing the business
Agreements - that there are no acquisition, deposition registration or voting of securities agreements
Warranties - that all company’s representations and warranties are true and complete to the best
In an Investment Agreement, the rights of the investors are usually outlined in detail after negotiations between the founders and the investors, to prevent future disputes. These prescribed rights involve rights to receive corporate reports, rights to participate and rights to register as an initial public offering (IPO). Pre-emption rights, which means that the current investors are given a priority to purchase shares before other new investors do, may also be included.
A Restrictive Covenant limits the shareholders’ ability to sell or to transfer ownership of the company. Sometimes, confidentiality agreements would also be incorporated in the Investment Agreement to ensure corporate information remains private.
A Shareholders Agreement is concluded between the shareholders of the company before or at the time of the investment. The agreement defines their respective rights and responsibilities, organises the management of the company and protects the interests of the minority shareholders (usually the investors).
If there is already a Shareholders Agreement in place, the new investor can be bound by entering into a Deed of Adherence. View an example of a Shareholders Agreement between 4 Parties here!
A Shareholders Agreement stipulates and protects the rights of all shareholders, whereas an Investment Agreement covers the investment made by the incoming, new shareholder(s). For instance, an anti-dilution clause can be incorporated to ensure the same proportion of ownership after subsequent capital raise. The Shareholders Agreement serves as an outline of the rights of shareholders over the company.
An Investment Agreement governs mainly the rights and obligations of the incoming investor(s). It protects the incoming investor(s) from entering into a dodgy startup business, as well as sets out the form of payment by the new investor(s). The investor(s) may choose not to invest in the company (or additional tranches) should the company fails to meet certain requirements. Fundamentally, it is a contract between company owners and the investor(s) who want to purchase ownership of the company.
Both agreements, nonetheless, serve as important documents essential to capital raising. They define the terms of the investment and set boundaries for the exercise and refrainment of power over the company.
A capital raising process is ensured smooth and compliant with legal requirements with both the Shareholders Agreement and the Investment Agreement in force. Jointly, they prevent potential disputes between shareholders with everything written in black-and-white. In some cases, the shareholders’ agreement and the investment agreement have been combined into one document.
When drafting your Shareholders Agreement, consider the following questions:
How much of the company does each shareholder own?
How much does each shareholder have to pay to get his/her share?
What are the rights of each shareholder under the corporate structure?
Is there any protection for minority shareholders?
Are there any restrictions to prevent shareholders from competing against the company?
Are there any dividend policies?
How should the shareholders exit or terminate their interests in the company?
Do shareholders have the right to abandon or to acquire shares?
Do Shareholders have the right to buy additional shares before a third party does?
What are the Accounting Policies in the Company?
What if the Shareholders come across a Deadlock Resolution or Dispute?
To know more about Shareholders Agreements, be sure to check out What is and How to Prepare a Shareholders Agreement? (Free Templates) on DocPro.com.
Another way for investors to participate in the equity capital of the company is to buy shares from existing shareholders.
The main difference between this and investment into the company is that it is capital raising for the selling shareholders instead of the company. The exiting shareholders would cash out but the company would not be getting the much-needed capital for expansion.
It is also possible for the selling shareholder to put some of the money back into the company or the new investor(s) may inject more capital of the company after acquiring control.
Generally, a Sale and Purchase (S&P) Agreement is a legally binding contract between a buyer and a seller regarding a transaction. Here, we refer to a Shares Sale and Purchase Agreement which governs the transfer of shares to a new investor at an agreed price. Click here to view an example of a Sale and Purchase Agreement regarding the Sale of Shares for free!
The seller shareholder may choose to sell all or part of his/her shares, but only the shares he/she owns. A Shareholder cannot sell more than what he/she owns, i.e. the shares of other shareholders.
Under a Share Sale and Purchase Agreement, the company does not need to issue new shares to shareholders. Therefore, this form of capital raising is especially popular in the situations for:
Founders, who do not want to sell or dilute their current ownership of the company
Current investors, who would like to cash out their investments immediately by selling shares
After a transferral of shares, remember to send a Company Record of Shares Transfer to the registration body in your country. Or else, the validity of the investment may be hampered!
A Share Sale and Purchase Agreement is used when an existing shareholder would like to sell his/her ownership of the company to another party. On the contrary, a Share Subscription Agreement is used when a company issues initial shares to shareholders.
A Share Sale and Purchase Agreement may echo with the adherence clause incorporated in the Investment Agreement. If an adherence clause is in force, obligations provided in the Investment Agreement would be attached to future transferees. To do so, the transferees are commonly required to enter into a Deed of Adherence with all other company owners.
An investment agreement is a contract defining the terms of investment which a single investor invests in a company owned by managers/founders. The agreement is drafted in neutral form.
An investment agreement where a syndicate of private equity investors make loans and invest in a company. The form is drafted in the neutral form with the appointment of a manager by the investor.
A Two-Party Shareholders Agreement to be entered into upon completion or establishment of the Joint Venture Company with standard clauses for minority protection. This agreement is drafted in neutral form.
A sale and purchase (S&P) agreement between a Buyer and a Seller with no warranties. This is suitable for a sale/transfer of shares. This agreement is drafted in favour of the Seller.
A sale and purchase (S&P) agreement between a Buyer and a Seller with no warranties. This is suitable for a sale/transfer of shares. This agreement is drafted in favour of the Buyer.
Please note that this is just a general summary on Capital Raising and Investment Agreements for Startups under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your local legal advisor.
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