- John Deane
- Updated: Mon, 21st Nov 2016
If you are not clear on the investment terms at the beginning, it will be costly and difficult to change them later. We have significant expertise in drafting and reviewing investment terms and can suggest ways to ensure you secure a better deal.
Our services for investment agreements includes:
We work with both businesses and investors across many sectors with a focus on the private sector. We do see both sides of the debates. We know that investors and the businesses need to get along and work in collaboration to avoid hostile stand offs.
Our clients range from start ups to larger established businesses at VC funding stage.
Top legal points for an investor to consider
The top legal points we see of importance based on experience are set out below:
- Powers of veto afforded to the investors;
- The level of control an investor can exercise;
- The investor’s ability to control the board;
- Remuneration and pay structures; and
- What happens if the investment fails.
Issues reserved for the investor to approve or determine
Usually the investors’ consent is required for fundamental issues, such as:
- Significant acquisitions and disposals.
- Dividend declaration and payment.
- Material changes to the company’s business model, such as technology development i.e. the investor should approve a “pivot”.
- Significant investments.
- Long term or unusual contractual commitments. A major contract sold at marginal cost is one of the fastest ways to go bankrupt.
The control of investors
The business and investors will negotiate the extent to which the investor manages the company. The scope of the board is usually set down in the investment agreement.
What right does the investor have to appoint directors?
We can assist you to define how many directors the investor can appoint. We can discuss if the appointment will be effective immediately or on completion or whether the appointments will be expressed as a right in the investment agreement to be exercised at a future date.
It is not uncommon for an investor to be granted the right to appoint a non-executive director. For example, in a Fintech company, the investor may seek to appoint an individual that has experience in launching payment platforms to observe and vote on matters presented to the board. That will help in realising a return.
Can the investor appoint anyone to act?
We can help you decide whether the investor should appoint anyone to act as his alternate director, or whether you would want your preferred investor to appoint an individual in the industry or with the requisite level of experience.
What management information can the investor director access?
The investor will probably demand access to all relevant information and board papers, including:
- Business plans,
- Management accounts,
- Board papers.
How much will the investor director be paid?
Some investors also expect a considerable amount of income for their advice. We can help you consider:
- Frequency of pay reviews.
- Index linked increases.
- Payment for reasonable out of pocket expenses.
- Reimbursement of observers for reasonable out of pocket expenses.
Who appoints the chairman of the board
What is the process for appointing a chairman, does the chairman get a casting vote and does the chairman have any special powers or rights?
Who gives the warranties?
Generally, it’s the target company, the founders and directors who give the warranties. This group is called the warrantors. We can help decide whether all managers give warranties, or, more likely, just those involved in the daily running of the business.
Attempts to limit warranties
Common limitations include:
- The time period during which the investor can bring claims;
- The investor’s knowledge, whether implied or express;
- A cap on the total amount of warranty claims;
- A cap on each manager’s liability. For example a limitation of three times salary or remuneration or a de minimis level that must be reached before the investor can claim.
So what if something goes wrong, and the investor brings a claim? Do the warrantors have joint liability, i.e. each liable for the total amount, or several liability, i.e. just liable for their share? If several liability then should there be a separate deed of contribution to apportion any liability under the warranties amongst the managers of the target company.
In addition, it is always best to consider exit at the early stages. If the investor decides to leave the business, how will their shares be dealt with? For example:
- Will the investor be entitled to sell their shares on the open market?
- Will the investor be required to first offer their shares to the company, or existing shareholders pro-rata?
- What price will the shares be sold for? Will there be a distinction in price for a “good leaver”, and “bad leaver”?
Our experience puts us in a position to tell you what is reasonable and what is not.
What the investee business needs to consider
Investor due diligence is crucial. The top legal points for the investee business to consider are:
- Protecting confidential information;
- Managing directors and shareholders;
- Incentivising employees and investors;
- Reducing risk at employee level.
If you do not undertake some basic planning before seeking investment you may not achieve your goals.
If you’re approaching more than one investor, then each investor should probably sign a confidentiality agreement. That will give the company appropriate protection.
Exclusive negotiating period
Your preferred investor may request an exclusive negotiating period. Should you grant this request? Will there be a single round of investment, or several? We can assist you with these questions.
Heads of Agreement
We can assist you with preparing heads of agreement for the investment, which can assist with the whole process of the investment. The heads of agreement will be a base to work from for the purposes of the investment.
Is the investment conditional?
Typical conditions include:
- The target company’s managers signing new service agreements, approved by the investors, with the target company; or
- FCA approval; or
- Registration of trade marks; or
- Appointment of non executive directors.
Each investment differs. However, from our experience we will know what conditions are required, and what are reasonable.
When is shareholder approval required?
Commonly, approval is required to increase share capital and amend the target company’s articles of association. Articles of association are often drafted to compliment the investment under the investment agreement.
Does the investor, or their appointed director, get unrestricted access to the company’s accounts and databases?
Investor/directors should focus on strategic issues. Unfortunately, some angel investors meddle with trivial issues. We can assist you in restricting their access to certain items.
Investors will probably want an obligation to prepare and circulate minutes after each board meeting. If an observer attends, then the minutes will probably be circulated to both the observer and investor.
Handling confidential information
It pays to consider what information the investor will be entitled to. Will the investor be subject to strict confidentiality requirements? This is particularly important for tech and knowledge driven businesses where the value is in the know how and databases.
Incentivising the team
Often investors back people, e.g. their skills, capabilities and knowledge, rather than physical assets. To cover for that, and to provide an element of flexibility, there may be employee share schemes operated. The most common is EMI options.
Covering off risk at employee level
Investors will be keen to limit the dilution for employee share awards. This is most commonly achieved via an option pool. The standard pool is between 10 – 20% of issued share capital.
That works to ensure that a specific percentage of the company’s share capital is reserved solely for employee share schemes. Investor consent will be required if the company wishes to issue shares in excess of this pool.
Special considerations – Fintech investment
The business may need FCA approval.
For example, if you are running a Fintech business the following types of services need FCA approval:
- providing greater access to and convenience of financial services; or
- providing greater efficiency of financial services; or
- providing inroads into a more decentralised financial system, i.e. diluting the oligopoly of the banking world.
There are a number of other businesses needing FCA approval including crowd funding platforms, seed enterprise platforms, peer to peer lending, and applications that effect the processing of payments. FCA approval should be a first step for these businesses. We manage that process.
Intellectual property and Fintech
A Fintech business will have valuable intellectual property rights. Those rights are usually within the software developed. Software can not usually be patented. Therefore, how will the intellectual property stay protected?
Our intellectual property team can assist with:
It is not uncommon for the investee business to warrant to the investor that the business’s intellectual property rights are adequately protected. We manage that process for you.
Further rounds of financing
If you do not deal with powers to issue new share capital and dilute your investment you will have little control as a minority investor. Dilution and the circumstances in which you can be diluted are a key factor.
We can help you consider the following:
What classes of shares will there be?
For instance, you might want to motivate employees with shares, but wouldn’t want them too involved in the company’s strategic direction. You might then seek to issue only B ordinary shares to the employees. Such shares may not carry rights to voting, i.e. excluding employee input.
Can the investor transfer the company’s shares to other entities within its group?
This flexibility could offer the investor some tax advantages. However, what if the investor sells to a company within its group, perhaps to a rival? If so we can help you decide whether the flexibility should extend to any company within the investor’s group or only to named entities.
If transfers are permitted, we can help you decide whether pre-emption rights should apply, sometimes called a “first option to buy”.
What transfers are free of pre-emption rights, e.g. managers may want to transfer their shares to close family members for tax planning purposes? Investors may want to transfer shares to other group companies.
The recipient of the transferred shares should execute a deed of adherence to the investment agreement. That deed will bind the recipient to the investment agreement’s terms.
Dealing with investor and founder exits
Investors want a viable exit. That’s usually when they realise their capital gain. We can assist you in deciding:
How to manage each investor’s exit
Typically the parties require the company to notify the investor of any approach to buy the target company, its business, or assets. Usually the company will wish to be notified if the investor receives an approach.
We can insert provisions that the investor will not give any warranties on exit. The only exception is title to the target company’s shares.
Should the investor be given a right of first refusal to buy the shares of the founder if the founder seeks to exit? What if the founder seeks to sell the whole company? Will the investor be “dragged” into a sale?
With smaller scale tech start-ups and lean start-ups, the founders and investors will be shareholders and directors. The founder will also be an employee, and the investor may too.
On any exit, it is important to consider the relationship between these positions. If an investor is also an employee, it will not be enough to just buy their shares on exit. An element of protection will be required and we can help facilitate that.
Track record of working with businesses and investors
We act for investors, private companies, partnerships, and shareholders across a range of sectors. We also have expertise in advising management buy out teams.
Our track record means that we can:
- Optimise an investment agreement for tax and financial returns;
- Manage new share issues;
- Seek FCA approval for financial technology companies;
- Protect and manage intellectual property rights;
- Draft shareholder agreements;
- Ensure compliance with Enterprise Investment Scheme (EIS), SEIS and tax relief requirements; and
- Negotiate the business sale, especially the warranties and indemnities.
Investment agreements require company, tax, IP & employment law expertise. Our tight-knit team possesses this expertise. Why not email or call me now to arrange an informal discussion.