10 Feb 2023
19 Mar 2021
When your company raises capital, you will need to draw up several kinds of legal documents to support and ensure that the process goes seamlessly. One of the most important contracts you will enter during the fundraising round is an investment agreement. An investment agreement is a contract between the investor and the company. The investment agreement will set out the main contractual terms and conditions for the investor to purchase ownership of your company. This should not be confused with a shareholder agreement, which is a contract made between a company and its shareholders and concerns how shareholders are to exercise their rights/obligations. This article will first explain what an investment agreement is, and then outline how you should write your investment agreement.
During investment transactions, an investor gives money to the company in exchange for shares. The investment agreement which accompanies lays down the terms governing the 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 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. The proper safeguarding of interests is especially important for start-ups and SMEs who are in their early funding rounds and likely cannot afford a costly and expensive legal battle down the line.
Secondly, it helps 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 means that if relations between the company and investor are strained, both parties know what they are entitled to do.
We have created comprehensive template investment agreements for you to use including different forms each drafted to favour a different party – the investor, the founder/manager, or the neutral. You can find a suitable template here.
If you are looking to write your own investment agreement instead, here are the key clauses you should include:
It is common for investment agreements to require that any transferee of shares originally obtained by the investor, enter 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 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 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 situations are accurate 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 makes the agreement a way of mitigating risk. Despite investors doing their due diligence, there may still be certain hidden risks that due diligence cannot help identify. Warranties serve as additional surety to mitigate risks.
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 investor's attention any matter which may cause any of the warranties 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 purpose of protecting their investment in 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, the company is also often obliged to deliver the management and financial reports periodically to the company.
Investment agreements often include a list of actions, that the company shall not take, without the prior consent of the investor. The requirement for the investor to provide consent restricts the ability of the company to do things that might jeopardise the investor’s investment in 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 discussions with the company, the investor is likely to become privy to a lot of confidential information about 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.
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.
Below 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 the management of the company must provide certain financial documentation to investors on a periodic basis. Common documents include business plans, budgets, and management accounts.
Management also often must 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 will have to be provided.
In addition, the investors are likely to require access to the company’s accounts 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 at 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 ensure that the management runs the company in the interests of the shareholders, such as the investor. They do this by voting on major decisions pertaining to the company and by contributing their expertise to the company, ensuring that from a strategic perspective, the company is more likely to succeed.
In addition, investors also often reserve observer rights. This allows the investor to send non-directors to board meetings and receive all information given to the directors, albeit without the ability to vote.
Investors use observer rights to bring other members of their teams, with expertise different from 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 grows.
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 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, learn more 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.
As mentioned earlier, there are many similarities between investment agreements and shareholders agreements, but they are not to be confused.
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 where an investor invests money in exchange for equity in the company. An investment agreement is specific to that 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.
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