When you reach an agreement about a venture capital investment, the investors’ contract serves to formalize the reciprocal rights and duties of the investors and the company being invested in.
This contract’s importance cannot be overstated: it will determine what the investors can insist upon, what the company is obliged to offer the investor, and how the investment should be managed. In short, it is a contract that not only determines who profits from the investment’s success – it also determines whether or not that investment succeeds in the first place.
In this article, we provide a concise overview of everything to keep in mind when drafting and negotiating the investors’ contract.
The Bare Bones of an Investors’ Agreement
Regardless of its particular structure, every investors’ agreement will cover the same subject matter, more or less: the basics, the investment, the return on investment, and reporting and control. We’ll unpack each of these in more detail:
Every investors’ contract should cover the bare basics required to make the contract’s scope and operation clear. This will entail information about the identity of the contracting parties, the date and place of the agreement, a list of basic terms and definitions, and valid references to other documents implicated in your agreement (for example, the startup’s articles of incorporation, bylaws, or shareholders’ register).
Importantly, the investors’ agreement should also include terms that provide for the agreement’s termination. This will be a clear description of procedures and remedies if one party intends to terminate the contract, provisions relating to alternative dispute resolution, and a clear statement of jurisdiction if there should be litigation in the future.
The investors’ contract should clearly describe the investment that is to be made, and what is to be received in return for it. The investment amount should be set out along with the proper mechanisms for its delivery.
If the investor receives equity in exchange for the investment, this should be clearly delineated in the agreement: the class and amount of shares, the price per share, any preferred rights attached to the shares, restrictions on transferability, and any other pertinent provisions. Be sure that the equity, and the manner of its delivery, is described in the contract in accordance with the company’s articles of incorporation and bylaws.
Most investors’ contracts will also contain specific conditions that must be met before the investment will be made, and the equity transferred.
From the investor’s perspective, the most important condition that must be met before the duty to transfer the investment arises is that the startup company must pass due diligence requirements.
During due diligence, the investor undertakes a detailed investigation of the affairs of the company. Usually the investors’ contract will stipulate what exactly must be confirmed by due diligence before the condition will be satisfied.
It is also common to include a stipulation providing that the investor can waive any of the due diligence conditions in writing. This is useful if there is some non-essential condition that is not met during due diligence, but the parties still wishes to pursue the agreement.
Some other suspensive conditions usually included in the investors’ contract are:
The passing of shareholder resolutions creating the necessary share capital and authorising its issuance
The receipt by investors of a satisfactory accountant’s report, audited accounts and management accounts of the company
Delivery of certificates or reports of title
Return on Investment
This aspect of an investors’ contract is fairly simple if the investment is made in return for equity. In such cases, it will simply set out what the company has to deliver in exchange for the investment: usually an amount of share capital.
If the investment is made in exchange for debt or convertible debt, the contract will be more detailed in this regard. It will specify the applicable interest rates, penalty fees, payment terms, and (if applicable) conditions for conversion.
Reporting and Control
This part of the contract sets out the investor’s right to monitor and influence how his or her investment is utilized. Because company management is conducted at board level, it is customary for the agreement to specify that the investor has the right to appoint one or more non-executive directors to the board. In other cases, the investor will have the right to appoint an observer to board meetings.
Other common provisions in this regard include a term obliging the company to make financial and other statements available to the investor at regular intervals, or to disclose material matters to the investors.
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