You have spent the last few months working on your start-up and your product has quickly gained traction. You think the time is right to take your product global. To do this, however, you need cash for which you need to fundraise.
One of the most important agreements any entrepreneur will enter into during any fundraising round is an investment agreement. It is thereby imperative that all entrepreneurs become familiar with what they are and how to write one.
This article will first explain what an investment agreement is, and then explain how to write an investment agreement.
In a typical investment transaction, an investor gives money to the company in exchange for shares in the company. An investment agreement lays down the terms governing such investment, in written form.
There are various terms that will need to be specified in the investment agreement. For instance, the agreed-upon price of the shares and when the investor is required to convey the funds both need to be specified.
The investor, in such an investment transaction, can be an existing shareholder of the company or a new shareholder of the company. The investor may also be a lead investor as part of a syndicate.
Investment agreements are extremely important for two reasons.
Firstly, as with any transaction, investment transactions pose many risks for both the investor and the company. These risks need to be properly managed by the parties to safeguard their interests. Properly safeguarding interests is especially important for start-ups and SMEs who are in their early funding rounds, and who likely cannot afford a costly and expensive legal battle down the line.
Secondly, it helps clearly outline the rights and obligations of the parties in a variety of situations. For instance, an investment agreement may specify what is to be done should there be a dispute between the parties. This will mean that should relations between the company and investor become strained, both parties have clarity as to what they are and are not entitled to do.
DocPro has comprehensive template investment agreements, including different forms each drafted to favour a different party – the investor, the founder/manager or neutral.
You can find and select a suitable template here.
If you are looking to write your own investment agreement, here are the key clauses you should include and familiarise yourself with:
It is common for investment agreements to require that any transferee of the shares which were originally obtained by the investor, enter into a deed of adherence.
A deed of adherence has the effect of treating the transferee as if they were an original party to the investment agreement. Therefore, the transferee, by entering into a deed of adherence, will be subject to all the terms and conditions of the investment agreement.
Sometimes, investment agreements specify that payments are to be tranched.
This means the investor will pay the entire investment amount in parts over time. Each payment is made conditional upon the achievement of particular agreed milestones. For instance, payment of a particular part may be conditional upon the development of a new product.
A warranty is a statement, made by the founders or management of the company, that certain facts or a certain state of affairs are accurate and true, at a specified point in time.
If the warranty turns out to be untrue, the investor will be entitled to claim damages if they suffered loss resulting from the falsity of the warranty.
Including warranties in the investment, the agreement is basically a way of mitigating risk. Despite investors doing their due diligence, there may still be certain hidden risks that due diligence cannot help identifying. Thereby, they may want additional surety to mitigate risks, in the form of these warranties that are expressly included in the investment agreement.
Founders/managers, who make the warranty, can generally qualify the warranties by using a disclosure letter. A disclosure letter basically allows the founder/manager to expressly bring to the attention of the investor any matter which may cause any of the warranties to be or likely to be incorrect. This in turn allows them to avoid liability for making an untrue warranty.
Typical warranties, frequently included in investment agreements concern:
The shares and constitution of the company
Liabilities and contracts of the company
Ongoing claims or litigation against the company
Tax liabilities and disputes
Investors often reserve a range of different rights in the investment agreement, for the purposes of protecting their investment into the company.
Common rights usually reserved by an investor in an investment agreement include:
Investors often reserve the right to request the management and financial reports of the company at any time. In addition to this right to request such reports, the company is also often obligated to deliver such management and financial reports periodically to the company.
Investment agreements often include a list of actions, which the company shall not take, without the prior consent of the investor. Such a requirement for the investor to provide consent restricts the ability of the company to do particular things that might jeopardise the investor’s investment into the company.
Common examples of such actions include:
Any amendment to the articles of the company
Incorporation of any subsidiary
Passing of a resolution to wind up the company
Sale of intellectual property of the company
Sometimes, investors reserve pre-emption rights and rights of first refusal in an investment agreement. These rights allow the investor to avoid dilution should the company decide to sell any additional shares to other investors.
During the course of discussions and negotiations with the company, the investor is likely to become privy to a lot of confidential information of the company.
A confidentiality clause is often included in an investment agreement to ensure such information remains confidential.
Confidentiality clauses protect the proprietary and sensitive commercial information of the company and explicitly state what information can be disclosed to third parties and what information cannot be disclosed to third parties.
Covenants not to compete, or non-competes, prevent the founders/managers of the company from competing with the company, whilst they are at the company, or after they leave the company.
Often, non-competes are included in both the employment/service agreements of the founders/managers and in the investment agreement with the company.
This is an exemplar covenant not to compete:
“Each Manager shall not without the prior written consent of the Company directly or indirectly at any time whilst he is a director or employee of, or a consultant to, the Company and during the Restricted Period engage or be concerned or interested in any capacity with any business concern which within the Relevant Area competes, or will compete, or is likely to compete with the business of the Company.”
Investment agreements often specify that management of the company must provide certain financial documentation to investors on a periodic basis. Common documents that must be provided include business plans, budgets, and management accounts.
Management also often has to provide audited accounts of the company to the investors. Sometimes, if the company is a parent company, the audited accounts of any subsidiaries may have to be provided and the group as a whole will have to be provided.
In addition, the investors are likely to require that they can access on request the accounts of the company for inspection.
In an investment agreement, investors commonly reserve the right to appoint a director of their choice to the board of directors. In some cases, investors also specify that there will be no quorum on any board meetings without the presence of these directors appointed by them.
Directors effectively serve as a ‘check’ on the management of a company. They basically ensure that the management of the company run the company in the interests of the shareholders, such as the investor. They do this by voting on major decisions pertaining to the company. They also do this by contributing their expertise to the company, ensuring that from a strategic perspective, the company is more likely to be successful.
In addition, investors also often reserve observer rights. This basically allows for the investor to send non-directors to attend board meetings and receive all information given to the directors, albeit without the ability to vote.
Investors use such observer rights to bring other members of their teams, with expertise different to that of the director they have elected, to provide guidance to the company. The company thereby benefits from a greater chance of success, increasing the likelihood that the investor’s investment is to grow.
It is important to include boilerplate clauses in your investment agreement. The term ‘boilerplate clauses’ refers to a group of standardised clauses which are always included in every contract. Boilerplate clauses are often included at the end of every contract with the main, more substantive clauses, included at the beginning of the contract.
An example of a boilerplate clause is a notice clause. Notice clauses specify how and to whom any notices to be served under the agreement are to be served.
Other common examples of boilerplate clauses include rights of third parties’ clauses, severance clauses and entire agreement clauses.
For more information on boilerplate clauses, check out our dedicated blog entry on boilerplate clauses. You can find it here.
Other basic clauses and components, necessary to make an investment agreement complete, should also be included. This includes the name and address of the parties, the date of the agreement, and the signature of the parties.
There are many similarities between investment agreements and shareholders agreements.
A shareholders agreement is an agreement entered into between the shareholders of the company which sets out obligations of the shareholders and outlines rules regarding how the shareholders are to exercise their rights with respect to the operations and management of the company.
An investment agreement, on the other hand, governs a specific transaction namely, where an investor invests money in exchange for equity in the company. An investment agreement is specific to this transaction only. It does not regulate the way in which shareholders are to exercise their rights in respect of the company on an ongoing basis.
DocPro Legal is a team of legal professionals with a passion for making quality documents and legal contract templates widely available to the public through cutting edge technology. Our lawyers are qualified in numerous common law jurisdictions including the United Kingdom, Australia, New Zealand, India, Singapore and Hong Kong. We have experience in major law firms and international banks with expertise in business, commercial, finance, banking, litigation, family, succession and company laws.
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