A cap table (capitalisation table) summarises the ownership of a business pre and post a fundraise, demonstrating the full breakdown of the Enterprise Value, including shareholders, debt and cash.
It is an essential tool that enables you to see the mechanics of your individual fundraise and to calculate specific figures for the legal documents, for example:
We have built an easy-to-use cap table template specifically for seed rounds.
All you will need to complete the template is:
Step by step instructions are included within the template, which is built using basic Excel formulae and thus can be tailored to fit your business and fundraise.
There are also a number of built-in checks in the model below the cap table. If any of these show an error, you'll need to check your inputs:
A cap table (capitalisation table) summarises the ownership of a business pre and post a fundraise, demonstrating the full breakdown of the Enterprise Value, including shareholders, debt and cash.
It is an essential tool that enables you to see the mechanics of your individual fundraise and to calculate specific figures for the legal documents, for example:
We have built an easy-to-use cap table template specifically for venture rounds where new equity is being issued.
All you need to complete the template is:
Step by step instructions are included within the template, which is built using basic Excel formulae and thus can be tailored to fit your business and fundraise.
There are also a number of built-in checks in the model below the cap table. If any of these show an error, you'll need to check your inputs:
Venture investors ordinarily will not subscribe for the same class of ordinary share held by the founders and seed investors, and will instead subscribe for a new class of ordinary share, sometimes called the An Ordinary Shares or Series A Shares.
The reason for using a different class of share is to attach certain rights to this new class, that will apply only to the venture investor. For this reason, this class may be referred to as a preferred class of share.
It may be that the two classes of ordinary share are identical from an economic perspective, but will have differing voting, transfer or exit rights. It may also be that the two have different economic rights also.
If you are raising money from an EIS or VCT fund, there are certain eligibility criteria that limit the extent of preferential commercial terms investors can attach to their class of share.
Otherwise, there is no theoretical limit as to what economic rights you can attach to the new class. Some common economic benefits attached to the new shares are:
These mechanisms are designed to enhance the return attached to these shares and reduce the reliance on an exit event for the realisation of a return. They can be used as a lever to negotiate a higher post money equity value – for example, an investor may be willing to invest £2,000,000 for 35% in equity with no preferential rights, or £2,000,000 for 25% for equity with a fixed annual dividend and an exit-only liquidation preference.
This resource provides an overview of the SEIS, EIS and VCT schemes to help you decide whether you would like your fundraise to offer the benefits of SEIS and EIS to incoming investors, and whether you can approach SEIS, EIS and VCT funds.
As every business and every fundraise is different, there is room for interpretation when applying the rules to a specific business. This is why companies usually seek (and investors usually require) advance assurance from HMRC that the round is likely to be eligible for SEIS, EIS and VCT tax benefits.
This resource will also guide you through when and how to make an application for advance assurance.
The Seed Enterprise Investment Scheme (SEIS), Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT) are Government initiatives designed to encourage investment into small and medium sized businesses by providing certain tax reliefs to investors who purchase newly issued shares, or who invest in a fund that invests in SEIS, EIS and VCT eligible companies.
SEIS and EIS differ slightly from VCT – individual investors can claim SEIS and EIS tax benefits, whereas VCT benefits are always managed and structured through a fund. A VCT fund is a specialist category of venture capital or growth capital fund – it is a company that has been approved by HMRC to invest in small, unlisted companies and provide specific tax advantages to its investors.
There is no minimum amount and the maximum amounts are as follows:
SEIS: Up to £150,000 through the life of the company (this allowance does not “refresh” and can be used only once by a company)
EIS: Up to £5,000,000 in any 12 month period provided no funds are raised through the SEIS or VCT schemes. If funds are also raised under the SEIS or VCT schemes, then these are deducted from the £5,000,000 allowance. An all-time maximum of £12,000,000 may be raised over the life of the company.
VCT: Up to £5,000,000 in any 12 month period, provided no funds are raised through the SEIS or EIS schemes. If funds are also raised under the SEIS and EIS schemes, then these are deducted from the £5,000,000 allowance. An all-time maximum of £12,000,000 may be raised over the life of the company. Note that special exceptions apply to knowledge-intensive companies, for example, these companies can raise up to £10,000,000 in any 12 month period.
INCOME TAX RELIEF
Relief from income tax of 50% of the cost of shares on a maximum investment of £100,000 in any single tax year
Relief if the shares are disposed of at a loss
Relief from income tax of 30% of the cost of shares on a maximum investment of £100,000 in any single tax year
Relief if the shares are disposed of at a loss
Relief from income tax of 30% of the cost of shares on a maximum investment of £200,000 in any single tax year
Relief from income tax on dividends
CAPITAL GAINS TAX RELIEF
Relief from capital gains tax of 50% if profits generated from the sale of an asset are used to invest in your business
Profits made on the shares subscribed for are exempt, excluding dividends
Deferral of capital gains tax if profits generated from the sale of an asset are used to invest in your business
Profits made on the shares subscribed for are exempt, excluding dividends
Profits made on the shares subscribed for are exempt
You can point investors toward the Government information for full details of the schemes here.
If you are raising directly from individuals via SEIS or EIS, these individuals will be subject to certain eligibility requirements to benefit from the schemes. They must:
The following criteria apply for businesses to be able to raise under these schemes. Note that there are criteria that apply to the present day and also those that must be met in order to maintain SEIS, EIS or VCT eligibility – many companies are unaware of the ongoing criteria and after their round, subsequently become ineligible.
SEIS
At the time that the shares are issued under SEIS, the company must:
Continuously from the date the company was incorporated, the company must:
Continuously from the date the SEIS shares are issued, the company must:
Use of funds:
Structure of the investment:
EIS
At the time that the shares are issued under EIS, the company must:
Continuously from the date the company was incorporated, the company must:
Continuously from the date the shares are issued, the company must:
Use of funds:
Structure of the investment:
VCT
At the time that the shares are allotted to a VCT, the company must:
Continuously from the date the company was incorporated, the company must:
Continuously from the date the shares are issued, the company must:
Note that If your company ceases to qualify for the scheme during the hold period (5 years for VCT), then your investors will lose their tax relief.
For all three schemes
HMRC define a “qualifying business activity” as one which is “conducted on a commercial basis with a view to the realisation of profit”. Fuller guidance is provided on the government website here. There are a number of specific exclusions (“non-qualifying business activities”), as follows:
Advance assurance is a letter from HMRC confirming that they agree that the investment would meet the conditions of the SEIS, EIS and/or VCT schemes.
This letter is often a pre-completion requirement for SEIS and EIS investors, and always a pre-completion requirement for a VCT fund.
The letter is not a requirement of HMRC; however. The schemes may still apply to an investment that has not sought advance assurance.
Advance assurance only relates to the business and the investment, and therefore relies on investors themselves meeting the relevant criteria for them to be eligible to claim.
Final eligibility of the investment can only be confirmed by HMRC once the investment is complete, and is subject to ongoing criteria as set out above.
Judging the right time to submit an application for advance assurance can be tricky as HMRC require the details of potential investors.
We suggest reviewing the eligibility criteria prior to engaging with investors so that you can fairly represent the likelihood of SEIS, EIS and/or VCT eligibility in your investor materials.
An application is usually submitted after initial indications of interest are received; for example, a signed term sheet.
If you are raising investment from individuals, you will be expected to submit the application yourself, on behalf of the business. To apply, you must either be the company secretary or a director. If you are raising investment from an SEIS, EIS or VCT fund, they may support you in doing this, or even do it on your behalf.
First you will need to prepare a draft application form and collate the required information.
We recommend downloading and completing our template to ensure that you have all the information that you need to hand, as you cannot save the HMRC application form prior to submission.
HMRC Submission
Once you have completed the word template and you’re ready to apply, click here to go to the HMRC form submission.
Create an initial long list of all of the investors that you would like to target, including individuals and funds. Undertake some background research on each to whittle the list down.
We recommend tagging those investors whom you intend to approach first. You may not want to approach preferred investors first so that you can gather some initial feedback before approaching your preferred investors.
Track progress with each investor, including any phone calls, meetings and keep a log of what information has been sent.
Seed capital is typically raised from:
A round can comprise investors under one or a number of these categories. When considering the optimal make up for your round, take the following into consideration:
As a first step, it is preferable to secure an “anchor” or “lead” investor. You may wish to discuss pricing and terms with the lead investor before settling on what to present to the broader network.
Approaching friends, family or your own business connections is relatively straightforward. The task becomes harder when you start approaching individuals that are not already known to you or the business. A lot of companies use LinkedIn, but this had led to some level of investor fatigue. Personal introductions are preferable but also rely on networks that you may not be a part of.
There are a number of organisations that specialise in raising investment from business angels and high net worth individuals, and hold the permissions and processes required to put investment proposals to them. These include brokers, angel syndicates and crowdfunding platforms.
The majority of Seed, SEIS and EIS funds are set up such that they are easy to get in touch with. Any initial outreach should include a succinct summary of the business and investment opportunity, with the investor presentation (assuming you are not putting in place an NDA) attached.
Try to personalise the communication – it is worth the investment of time – as investors will be wary of applications that look carbon-copied.
We generally suggest a staged approach – flooding the market with investment requests risks making the business look desperate. Investors are also always on the lookout for proprietary deal flow, i.e. investment opportunities that other investors haven’t yet come across.
This is a balancing act that should take place over at least a few weeks, so that feedback can be taken into account and relationships can be built.
A number of organisations host speed-dating-style events and pitching events which can help raise the profile of your fundraise if you are struggling to gain traction on a one to one basis with investors.
In all instances, try to meet with potential investors, as they will want to get to know you before committing any funds.
Be prepared to receive a high number of “no’s” – this is very common and even the most successful businesses receive them. Try to gather feedback from investors who decline to participate but don’t take the feedback too literally either. One of the most common reasons for investors to decline is that they lack sufficient confidence in the founders or the team. This may be rectified through pitching practice or team changes; but it is seldom given as a reason for decline.
The most common reason for decline is that a business has not yet “demonstrated sufficient traction”, or is “too early” in its development. This may also be accompanied with a list of milestones that the investor would like to see reached before they would consider investing. This, again, should be interpreted with some level of scrutiny, as it is the easiest and least offensive way to decline an investment opportunity and often, unfairly, leads to false hope and false starts.
Investment opportunities that resonate with investors will get a lot of attention and will often oversubscribe quickly. If you continue to receive a high number of “no’s” from a variety of sources, then it is best to pause and try to diagnose what isn’t resonating.
Here are some of the most common reasons for decline that we have come across in our experience as investors:
Our Investment Partners can shed some candid light on where the problems may be and whether they should be addressed through changes in the business, improvements in the investor materials or better curation of the type of investor to approach. You can view our consultancy options via your dashboard.
The investor presentation and a meeting with you is usually sufficient for an investor to decide whether they would like to explore further. Individuals may have little more than a few additional questions. Sophisticated investors and funds will request the business plan / financial forecast and may have a list of follow up questions to further assess the opportunity.
If the response is positive, individual investors will expect the company to issue a term sheet. Seed funds are more likely to put forward their own term sheet.
Venture rounds are normally led by an institutional venture capital fund but may also include seed funds, EIS funds, family wealth funds (also known as family offices), angel syndicates / platforms, corporate venturing funds, high net worth individuals and match funders.
Typically, a lead investor is sought to provide all, the majority or the largest portion of the round.
You can use our investor database to run various searches to populate this list – the database includes a number of institutional funds and funding organisations (but it is not exhaustive).
With an initial long list, use our profiles and the fund’s websites to undertake background research on each to understand the following:
Depending on each investors’ suitability and the strength of alignment, there are likely to be some funds you consider to be a “long shot” and others that are more achievable. It is sometimes helpful to approach those you consider fall into the latter category in order to test the pitch and gather initial feedback, before approaching others.
There is an element of momentum in securing investment. Starting conversations too early can have a detrimental effect if the business is not ready for early due diligence. Very early conversations should be positioned accordingly, so the investor is aware that you consider it an initial discussion and are not yet intending to commence a process. This will manage their expectations with regards to requests for further information and follow up, and give you time to prepare.
The majority of institutional funds are set up such that they are easy to get in touch with. A common misconception among small businesses is that they must secure a personal introduction in order to be considered for investment – while this can help prevent an application from being overlooked, it is unlikely to sway the judgement of the investor once an application has been received. There is a notable difference between an introduction and a recommendation – the latter of course may carry some influence. The quality of the investor presentation and the initial interaction with the management team will ultimately define whether an investment discussion is progressed. We therefore suggest spending sufficient time preparing the business before approaching investors and ensuring the presentation makes the right impression.
Initial outreach is usually in the form of an email, with the objective being to set up a meeting. An introductory email should include a short summary of the business and investment opportunity and should be tailored to each fund. The email should ideally reference why you are reaching out to that particular fund, for example, they have indicated an interest in the sector through a recent investment, or briefly why you feel there may be a good fit. The investor presentation should be attached to the email (assuming that you do not intend to put an NDA in place first).
While a significant number of “no’s” at the seed stage is usually no cause for concern, at the venture stage, this should not be ignored. The variability in the investment appetite of venture investors is narrower than that of seed investors and individuals, and therefore it is more important to address the cause for decline as it is likely to apply to other funds.
A number of “no’s” are issued as a result of poor communication of the business and investment proposition. Not being aware that this is the case, investors will not cite this in their feedback. It is important to look critically and objectively at your investor materials to ensure they are adequately communicating the investment opportunity.
If this is not the case, then there are concerns with the investment proposition, the business and/or the team. Seek feedback from declines so that you can understand where the concerns lie and address them.
The majority of companies attempting to fundraise do not manage to do so on first attempt, but many go on to do so at a later stage when their business becomes more investable or certain milestones are reached.
The feedback loop in the venture capital and private equity industry is relatively weak and not always accurate, given the sensitivity in rejection. Here are some of the most common reasons for decline that we have come across in our experience as investors:
Our Investment Partners can shed some candid light on where the problems may be and whether they should be addressed through changes in the business, improvements in the investor materials or better curation of the type of investor to approach. You can view our consultancy options via your dashboard.
A successful first meeting will usually result in a number of requests for further information, for example, the business plan / financial forecast.
The majority of institutional funds have an Investment Committee, which reviews and approves proposed investments. An individual investor or a “deal team” will work with you to prepare their recommendation for Investment Committee, usually in the form of a short written paper. The process followed and the decisions for which Investment Committee approval is required varies between funds, and therefore it is worth asking any funds that wish to progress discussions what their process is.
The next key milestone for discussions is the agreement of a term sheet – ordinarily provided by the fund or funds interested in participating.
We recommend appointing a law firm with experience of early stage equity fundraising to handle the legal documentation for the round. It is common for early stage companies to have articles of association and shareholders agreements that don’t function properly – and this often only emerges when these documents are put to the test, for example, through conflict with a shareholder or a shareholder employee leaving the business.
Law firms are typically appointed once a term sheet has been issued to investors and there is a reasonably high likelihood of agreement along the lines of the terms proposed. As a term sheet is not legally binding, it is not essential to have legal input up until this stage, but you may wish to seek a friendly view of your proposed term sheet in advance of circulation.
A clear matter scope and fee arrangement is important to avoid unexpected costs. We recommend working to fixed price scopes and agreeing to variations where there is scope creep. Fee estimates should be treated with some caution as they are not a cap.
Some essential items for the matter scope:
Some additional items you may require:
We recommend appointing a law firm with experience of venture stage equity fundraising (Series A, B etc.) to handle the legal documentation for the round.
Law firms are typically appointed once a term sheet has been issued and there is a reasonably high likelihood of agreement along the lines of the terms proposed. As a term sheet is not legally binding, it is not essential to have legal input up until this stage, but you may wish to in the course of negotiating the term sheet, in part to avoid more protracted negotiation during finalisation of the legal documentation.
A clear matter scope and fee arrangement is important to avoid unexpected costs. We recommend working to a fixed price scope and agreeing to specific variations where there is scope creep. Fee estimates should be treated with some caution as they are not a cap.
It is usual for institutional investors to provide the first draft of the legal documentation suite, in particular, the revised articles of association and shareholders agreement. This is because most have a standard set of documents that are applied across their portfolio. There are significant similarities in the structure of these documents across the industry which makes it easier for funds to co-invest. The British Venture Capital and Private Equity Association (BVCA) provide standard documents that are frequently used as a starting point.
As a result, your legal counsel’s primary role will be in reviewing and preparing commentary and amendments to the documentation.
Some essential items for the legal scope:
Some additional items you may require:
If the fundraise will be under the EIS or VCT tax schemes:
If the investor will undertake legal due diligence:
A term sheet sets out the principal terms that will form the basis of the final transaction documentation, in particular, the articles of association and the shareholders agreement, that will be entered into on completion of the transaction. The term sheet is not intended to be legally binding (with the exception of the confidentiality clause) and serves to act as a guide.
Before issuing a term sheet, you will need to have decided upon the principal terms surrounding the proposed seed round, though these can change through the course of negotiations up to completion.
In previous sections we have covered valuation (pre and post money valuation and the subscription price), and cap tables, where you calculate the percentage equity that new investors will hold.
There are a number of other terms that govern the interaction between the Company, the Board and the shareholders, and the commercial terms of the new investment.
We have prepared a template term sheet that contains a number of key terms and can be tailored to fit your specific seed round.
Note that institutional funds will ordinarily issue their own term sheet for you to review and agree. For seed rounds comprising individuals and smaller seed funds, you will be expected to provide a term sheet.
Size of the Round
The total amount of money (New Equity) being raised as part of the Seed Round, for example £500,000.
Post Money Equity Valuation
The valuation at which the funding will be raised, calculated by:
It is not necessary to also include the Pre Money Equity Valuation, but if requested it is:
Subscription Price
The price per share paid by the Seed Investors, calculated by:
Which should also equal:
Subscription Shares
The total number of shares that Seed Investors will subscribe for:
Proportion of Total Equity held by Seed Investors
This is the equity stake that the Seed Investors will hold in the business post the fundraise:
Ranking of Shares
This term sets out how the newly issued shares will rank relative to the existing shares in issuance. Is it typical for seed rounds for ordinary shares to be issued, i.e. just more of the same class as currently in issuance and held by the founders. In this instance, the newly issued shares will rank equally and participate equally with existing shares on voting rights, dividends and on a return of capital.
A new class of share could be created if they were to hold preferential or different legal or commercial rights and is significantly more likely to be required if raising from a seed fund or other institutional investor.
Note that one of the eligibility criteria for a round to be SEIS or EIS eligible is that newly issued shares are full-risk ordinary shares that are not redeemable or carry any preferential rights to the company’s assets on a winding up.
Information Rights
It is common to provide some information to your investors on a monthly, quarterly or annual basis. This may depend on how involved your investors wish to be, and may be as limited as the Company’s annual accounts, or may also include:
Investor Director
If you intend to offer investors the right to appoint a Non Executive Director, then you will need to include this clause. It is not necessarily a pre-requisite or expected and depends on your investors. They may seek the right to appoint one Non Executive Director between them, usually voted for in proportion to their shareholdings.
Warranties
Include this term if the Directors, Founders and/or the Company will provide warranties to the seed investors. Warranties may be limited to the accuracy of the current share capital, or may be more thorough and include the reasonableness of assumptions underpinning the business plan, the status of the Company’s trading, any outstanding liabilities or litigation etc. They are often minimal or excluded from seed rounds.
Option Scheme
If you intend to put in place an option scheme, for example an EMI scheme, as part of the transaction or shortly thereafter, then include a clause in reference to this, setting out the maximum equity percentage of the company the option scheme will represent.
New Issue of Shares
This clause summarises the ability of the company to issue new shares, and usually permits the company to issue shares as part of any specific option scheme, or with the consent of a proportion of the shareholders. Otherwise issuances may be offered pro-rata to existing shareholders.
Transfer of Shares
These set out the rights of each shareholder to transfer their shares to another individual or entity. It is common to have in place permitted transfers, which allow shareholders to transfer all or a portion of their shareholdings to immediate family or family trusts. Otherwise, it may be drafted that any shares intended to be transferred are to be offered first to the existing shareholders pro-rata to their shareholding.
Drag Along
A drag along right entitles a certain proportion of the shareholders (usually the majority) to force smaller shareholders into a sale of the company to a third party purchaser. This can be necessary to prevent smaller shareholders from refusing to sell their shares and preventing an exit event.
Tag Along
A tag along right entitles a shareholder to participate if an offer is made for a majority of the issued shares, on the same terms as those offered to the majority shareholder(s).
Investor Consents
Investor consents are sometimes requested by a group of new investors to give them some protection and control over key decisions made by the directors, the company and/or the majority shareholders.
Investor consents usually require a certain proportion of shareholders consent to a particular list of actions. Where this percentage is set depends on your current shareholder structure. If, say, following the seed round two co-founders will hold 80% of the shares and the new investors will hold 20%, then there is no point in setting the threshold at 75% as this affords no protection to the new investors – the co-founders could vote together and ignore their consent. In this instance, the threshold may be set at 85% so that if both co-founders agree, they will still require a further 5% to proceed.
The list of consents usually comprises significant decisions, such as a winding up or sale of the company, issuance of new equity, significant capital expenditure or the disposal of assets.
Pre-emption
Pre-emption rights allow shareholders to participate in future share issuances or fundraises if they wish to, and thus reduce or prevent their equity shareholding from being diluted.
Leaver provisions
Leaver provisions set out what happens to the shares held by directors that leave the company. They will usually define a “good leaver” and a “bad leaver”, for example, a bad leaver may be someone who is dismissed or who resigns. All of, or a portion of, their shares may be subject to repurchase by the company and any remaining shares are likely to lose their voting rights (be “disenfranchised”).
The purpose of leaver provisions is to discourage individuals from leaving, to ensure that those individuals that are no longer involved in the company are not able to vote on key decisions and that equity is returned to the company to incentivise a replacement, if necessary.
It is not essential to set these out in a term sheet for a seed round; however, investors may ask for your intentions with regards to these clauses.
Following a successful presentation and early due diligence, an offer from a venture investor will come in the form of a term sheet (sometimes called a “heads of terms”).
A term sheet sets out the principal terms that will form the basis of the final transaction documentation, in particular, the articles of association and the shareholders agreement, that will be entered into on completion of the transaction. The term sheet is not intended to be legally binding (with the exception of the confidentiality clause) and serves to act as a guide.
While specific terms can be negotiated at the point of drafting the final investment documentation, the purpose of the term sheet is to ascertain alignment on the deal proposed, so this is the time to raise and discuss any proposed amendments.
In this section we summarise the terms you may come across in a venture term sheet, and what they mean.
Valuation
This will usually be presented as a certain amount invested for a certain equity percentage. From this, you can calculate the valuation that the investor has applied to the business (the post money equity value, pre money equity value and enterprise value).
For example, an investment of £2,000,000 for newly issued shares representing 25% of the business.
The value of the business is then:
Arrangement fee
Some funds charge an arrangement fee that becomes due when the deal completes and is usually based on a percentage of total funds raised. Fees vary significantly between funds – they are relatively uncommon among venture capital firms but more typical of later stage funds, such as growth capital or private equity funds. The transaction fee usually serves the purpose of covering the cost of the process for your investor and is also one of theirs sources of income. Some investors also charge an ongoing monitoring fee.
Ranking of Shares
The term sheet will set out how the newly issued shares will rank relative to the existing shares in issuance.
Institutional investors and funds will almost always seek a new class of share to be issued alongside the existing ordinary shares held by the founders and early seed investors.
This is so that specific rights can be attached to this new class of share – these rights may be economic and/or legal in scope.
Note that one of the eligibility criteria for a round to be EIS eligible is that newly issued shares are full-risk ordinary shares that are not redeemable or carry any preferential rights to the company’s assets on a winding up. This may impact the extent of rights attached to the new class of share.
Priority return or liquidation preference
Investors may ask that their investment is returned to them before the remaining proceeds are split pro-rata between the ordinary shareholders. A multiplier may be applied to this right, for example, a 2x liquidation preference means that the investor is entitled to twice their investment before remaining proceeds are divided up. The exit valuation at which this will apply may vary – it may only be relevant if you sell your business below a certain value, and hence is there to provide the investor with protection if things don't go to plan.
Liquidation preferences of 1.0x are relatively common. Up to 2.0x are occasional and above 2.0x are relatively rare.
The commercial terms of a deal need to be considered as a whole and not viewed in isolation, so consider this alongside the implied valuation, dilution and any other economic terms within the term sheet.
Some companies agree to higher liquidation preferences in return for giving away a lower equity stake in the business.
Participation
Investors that hold preferred shares may also ask for a portion of the proceeds owed to ordinary shareholders in the event of a sale, called “participating preferred shares”. There may be a cap applied to this participation, for example, the investor may receive a portion of the proceeds until they have received 2x their initial investment, and after that all proceeds will be divided among the remaining ordinary shareholders and the investor will not participate any further.
Dividend policy
Investors may request the right to participate in any dividends distributed to ordinary shareholders. In certain circumstances, they may also seek some form of preferred dividend, paid before any dividends to ordinary shareholders, provided that the company has sufficient reserves. They may also have the ability to veto any dividend policy.
Drag Along
A drag along right entitles a certain proportion of the shareholders (usually the majority) to force smaller shareholders into a sale of the company to a third party purchaser. This can be necessary to prevent smaller shareholders from refusing to sell their shares and preventing an exit event. Drag along rights are very common in venture term sheets as investors need to be confident of securing an eventual exit.
Tag Along
A tag along right entitles shareholders to participate if an offer is made for a majority of the issued shares, on the same terms as those offered to the majority shareholder(s).
Pay to Play
This clause requires that all investors contribute a certain amount to any future fundraising, and if they don’t they may lose certain rights, for example, be forced to convert their preferred shares into ordinary shares and thus lose their preferred rights. If you are raising money from multiple investors, those investors that are not well placed to provide further funding down the line may be put off by this clause as they may be faced with an inevitable loss of rights.
Information Rights
Investors may require certain information to be made available to them on a monthly, quarterly or annual basis, which could include:
Non Executive Director or Investor Director
Institutional investors may require the right to appoint a Non Executive Director to the Board – this may be an individual from their own firm or an individual they introduce from their network, or both. They may also have the right to make this person the Chairman.
If a number of funds are participating, this right is usually reserved for the lead investor to prevent the board becoming too crowded.
Warranties
The directors, founders and/or the Company will be required to provide warranties to the new investors. Warranties will vary in scope depending on the investor, from warranting the accuracy of the current share capital, to the reasonableness of assumptions underpinning the business plan, the status of the Company’s trading and any outstanding liabilities or litigation.
If you agree the term sheet and progress through due diligence to completion, you will produce a disclosure letter which can be used to disclose any relevant information against these warranties and protect yourself and the company from a claim being made in respect of those specific items. For example, you may be required to warrant that there are no current employment cases against the company – if there were to be one, this would be described in the disclosure letter.
Option Scheme
If you intend to put in place an option scheme, for example an EMI scheme, as part of the transaction or shortly thereafter, then this should be explicitly mentioned in the term sheet and should set out the maximum percentage of the issued share capital that the option scheme will represent.
Investors will take dilution from options into account when calculating their anticipated return. They may seek a higher equity percentage to compensate for a large option pool.
Up to 10% of equity is relatively common for an option pool to be allocated to key members of the team.
Transfer of Shares
These set out the rights of each shareholder to transfer their shares to another individual or entity. It is common to have in place permitted transfers, which allow shareholders to transfer all or a portion of their shareholdings to immediate family or family trusts. Otherwise, it may be drafted that any shares intended to be transferred are to be offered first to the existing shareholders pro-rata to their shareholding.
Investor Consents
Investor consents are often required by minority investors to provide them some protection and control over key decisions made by the directors, the company and/or the majority shareholders.
Investor consents usually require that a certain proportion of shareholders consent to a particular list of actions. Where this percentage is set depends on your current shareholder structure. If, say, following the fundraise two employee shareholders will hold 80% of the shares and the new investors will hold 20%, then there is no point in setting the threshold at 75% as this affords no protection to the new investors – the existing shareholders could vote together and ignore their consent. In this instance, the threshold may be set at 85%, say.
The list of consents usually comprises significant decisions, such as a winding up or sale of the company, issuance of new equity, significant capital expenditure, key hires or the disposal of assets.
Pre-emption
Pre-emption rights allow shareholders to participate in future share issuances or fundraises if they wish to, and thus reduce or prevent their equity shareholding from being diluted.
Leaver provisions
Leaver provisions set out what happens to the shares held by directors or employees that leave the company. They will usually define a “good leaver” and a “bad leaver”, for example, a bad leaver may be someone who is dismissed or who resigns, and a good leaver may be someone who becomes incapacitated through illness or dies. All of, or a portion of, their shares may be subject to repurchase by the company and any remaining shares are likely to lose their voting rights (be “disenfranchised”).
The purpose of leaver provisions is to discourage individuals from leaving, to ensure that those individuals that are no longer involved in the company are not able to vote on key decisions and that equity is returned to the company to incentivise a replacement, if necessary.
Swamping rights
Minority investors may define certain circumstances in which they will have the ability to take voting control, i.e. will hold 51% or more of the voting rights in the company. These rights may be invoked for any reason or could have specified triggers, for example, the company underperforming, a key director leaving the business or a breach of banking covenants.
