- John Deane
- Updated: Mon, 21st Nov 2016
There are legal pitfalls when raising investment but our knowledge on how to structure the investment can help you avoid them. We have experience in acting for both investors and the businesses and also solve issues arising when bank finance is involved.
Our service for dealing with the legal issues arising upon raising investment includes but is not limited to:
We advise on all stages of debt or equity investment from the initial stages through to management buy-outs, additional acquisitions and trade sales. The business sectors to which we apply our specialist knowledge are diverse with particular expertise in dealing with hi tech businesses.
Debt financing may be attractive. This could be for a number of reasons, one being to prevent equity dilution where you are a founder wishing to retain control. Debt financing is available through a variety of streams, for example peer to peer lending, angel investment, or the banks. Mezzanine finance involves a number of lenders, each with their own agenda.
Risks with debt financing
The parties do need to spell out the repayment dates within the financing agreement, and the interest rate to be applied. Interest should be no more than what is reasonable, tailored to the level of finance and the risks of the business. It is important that the interest rate should not be a disguised penalty rate.
Where a debt financing agreement is silent on repayment dates, the general rule is that the advance is wholly repayable on demand. This is more of a problem for the business than the investor. A good loan agreement fit for purpose will deal with:
- The requisite degree of certainty specifying the trigger events for repayment;
- Failing a trigger event the final date for repayment;
- Record the intention that the monies are repaid on the repayment date;
- The lender’s right to refuse a further loan advance from another party, often termed a “negative pledge” clause; and
- The lender’s rights over the business’s assets, if secured.
Personal guarantees required by the bank
Banks will often require undertakings from directors and key shareholders before lending to the business or extending an overdraft facility. We do provide the independent legal advice that the directors or shareholders are required to obtain.
Resolving issues arising with equity finance
An element of control is a necessary function for any investor and we look to provide the solutions.
Sophisticated investors often look to invest in funds to spread the risk. The structure of each fund differs. The funds will often encompass an umbrella company that receives the investment, and then passes the investment through a number of subsidiary portfolio companies. However, the yield will only be received through the umbrella company.
We undertake due diligence on behalf of investors in these schemes to provide the full picture pointing out salient features an investor may miss but which are important.
To afford the investors flexibility, it is increasingly common for a private company to have a number of share classes. This is often termed alphabet shares, to reflect various rights and restrictions given and placed on share classes. Different investors have different requirements, thus the creation of different share classes caters for this.
Share classes in practice
For example, a company may have four share classes, as follows:
- A shares – preferential dividend rights, i.e. dividends before B, C, and D shares. Preferential shares.
- B shares – dividend rights, capital rights, and voting rights. Full control shares.
- C shares – dividend rights, no capital rights, but voting rights. Immediate income but not advisable for long term growth.
- D shares – dividend rights, capital rights, no voting rights. Financial returns, but no control.
We consider requirements and then tailor the legal documentation accordingly.
EIS & SEIS approval
For investors, there are generous tax reliefs available under the EIS and SEIS schemes. If you’re looking to attract investors, we obtain HMRC’s approval for your business, thus making your proposition even more attractive to investors.
New ways of raising investment
Bank financing is no longer readily available. Across many industries alternatives to bank finance are being devised. Take for example, our experience with the new breed of lean start ups, financing in the film and TV sectors and patterns emerging for MBOs.
Lean start ups
The major difference between financing for a lean start up compared to more traditional launch models is timing for when the product goes to market. Under the lean start up there are attempts to sell the product or service at an early developmental stage. A lean start up entrepreneur will talk to customers, who they call beta customers, at an early stage, and ideally receive advance money to build their solution in place of banks.
The idea is that reaching out to customers in this way not only provides funding solutions, but also, provides data about customer preferences before any launch. We provide the finance documentation under which the customers invest and deal with special discounts and repayments that are often offered on launch.
Film and TV sectors
By this structure, a broadcaster will make a payment to the production company pre-production. In return for that payment, the production company will enter into an agreement with the broadcaster, which gives the broadcaster the right of first exploitation. Broadcasters will find it easier to raise funds than production companies which are usually relatively small private companies.
The production company will usually have to prepare a production budget, which is sent to the broadcaster pre-advance. We assist with this process and cover off risks to retain rights for the production company itself.
Using a joint venture for the finance for production companies
A production will usually involve a writer, and the production company. Resources are then pooled to create a limited company that owns the rights in the production. An appropriate split with regard to income, capital, and voting will be required. We assist with the negotiation process to protect positions.
Spinning out similar concepts
Collaboration agreements and joint ventures used in other sectors such as technology companies taking products involving artificial intelligence to market can operate along similar lines often with large research institutions putting up the finance in place of banks or private individual shareholders. The Fintech market is also often sponsored by larger institutions looking to invest in these high growth businesses and providing the finance. We can review proposals and explain the implications.
Raising investment for a management buy out
Our experience will provide you with ideas on how an MBO could work in your business as a way of raising finance for shareholders looking to exit. We have represented both MBO teams buying into the business and shareholders selling to the MBO team.
An MBO can be structured with a buy out agreement under which future profits are used by the MBO team to fund the exit for shareholders leaving the business. This can be helpful for businesses where the MBO team would have difficulty raising bank finance. The buy out is often run in conjunction with a company share back from shareholders leaving the business. A buy back is a way to withdrawing profits from the business and providing shares to the new team whose shareholdings increase following the buy back.
Investor due diligence
Your business needs to be attractive to investors. We work with businesses seeking investment to help them position themselves favourably to potential investors.
Investors will look at a number of aspects in addition to financial performance which we help with such as:
- The commercial contracts;
- The company’s constitutional rules set out in its articles;
- Powers reserved under the shareholders’ agreement governing matters such as dilution of equity and the issue of new shares – investors are typically seeking powers of veto; and
- Adequacy of the protection of intellectual property.
Both investors and the business seeking investment need to safeguard data the investors may become aware of such as trade secrets, customer lists and research and development plans.
We work in understanding the business and its market to ensure that the restrictions are relevant and enforceable.
The risk is, if the compliance aspects are not dealt with the investor finds that it is not the legally registered holder of any charge or shares. Many investors ask us to oversee compliance for them.
Under UK company law there are various shareholder resolutions that are required to validate the issue of new shares in return for financing. A process for obtaining shareholder resolutions needs to be followed if the share issues are to be valid and enforceable.
Filings at Companies House
Shareholder resolutions, changes to the articles, and charges over the company assets taken as security for a loan need to be filed at Companies House.
Our experience shows that many businesses and investors slip up on the filings at Companies House which is often the final hurdle. We will ensure you are compliant and that appropriate filings are made at Companies House within the strict time limits – if you fall foul of the time limits then there are enforcement consequences later down the line.
HMRC scrutiny when raising investment
HMRC are increasingly asking to inspect investment documentation relating to financing so it is ever more important to structure matters correctly and record decisions taken by directors.
Obligations on directors
Directors have duties, one being to promote the interests of the company.
Directors who skip over this requirement may discover they have created a range of actions which could be brought against them.
We do work with fund raising initiatives, including crowd funding, which are regulated by the Financial Control Authority (“FCA”). Different considerations apply to such fund raising exercises. We do deal with the drafting of the prospectus documents and solve ancillary issues which often arise. If the FCA’s requirements are not met, then all parties are at risk.
Our track record in resolving the legal issues arising under the investment process
We act for investors, private companies, partnerships and shareholders across a range of sectors. Our track record on raising investment is as follows:
- Working with an app developer seeking EIS investment to enable it to become one of the leading providers of downloadable games from app stores.
- Working with a restaurant looking to raise further investment via the SEIS scheme.
- Drafting convertible loan notes for an estate agent. The loan notes entitled the investors to convert their loan into equity on the happening of a trigger event. One trigger event was a sale of the business.
- Drafting, reviewing and advising a facility agreement for an educational business that was receiving investment.
- Reviewing and advising a high growth technology platform on the heads of terms it had received from a private equity firm seeking to invest. We created separate classes of shares to ensure that the founders retained control at voting level.
Raising investment is a process that requires legal advice. For the business, procedural steps have to be complied with, and for the investors, its ensuring that the paperwork reflects the terms agreed. We work on both sides, and provide the advice needed to meet objectives. Our experience helps streamline the process.