It is not uncommon for growth capital investments to comprise a loan note or similar debt-like instrument alongside equity.
In the instance that a loan note forms part of the investment, then a Loan Note Agreement will be entered into on completion.
This agreement sets out the terms of the loan note, specifically:
A first draft of the loan note agreement will be prepared by the investor’s legal counsel, and it will be part of your legal counsel’s scope to review and comment.
The ability for the company to repay the loan note prior to maturity may be important, particularly if the interest rate is high or the interest is rolled up. Investors that have invested through a mix of equity and loan notes may not be comfortable with repayment of the loan notes too early in the investment cycle. It is advisable to check the process and consents involved, and if any penalties apply.
The events of default may be broader and more commercial in nature than those typically seen in banking documentation.
A redemption premium may be applied to the principal sum on repayment of the loan. This redemption premium could be payable in full even if the loan is repaid early - in which case, the cost of capital for the company would increase.
Alongside the adoption of the revised articles of association and signing of the shareholders agreement, there are a number of other documents required to complete the seed round. Drafting of these documents should form part of the scope of works for your legal advisors.
A share certificate will be produced for each seed investor, setting out the number of shares they hold, the class of share (most likely ordinary shares for a seed round) and the nominal price per share (often a penny or a pound).
Each share certificate is signed by director of the company and witnessed.
A board minute will be prepared that will approve:
The board minute should also:
The board minute is signed by the Chairman of the board.
This ordinarily takes the form of one document with two resolutions:
The document is signed by the existing shareholders of the company.
If no warranties have been provided, then a disclosure letter is not required.
If warranties have been provided, then the warrantors and the company may wish to provide a disclosure letter, which sets out information relevant to the warranties.
For example, the founder (if one of the warrantors) may have provided a warranty that there is no outstanding litigation with any former employees. If there is any outstanding litigation, then this would be disclosed in the disclosure letter and referenced to that particular warranty. This ensures that the seed investors are aware of these issues and provides legal protection to the warrantor, as the investors would not be able to make a claim against the warrantor for breach of warranty in relation to that particular litigation. If the outstanding employee case was not disclosed and were to come to light after the transaction, then the seed investors may be able to claim for breach of warranty.
The disclosure letter is signed by the warrantors and the seed investors, to confirm receipt.
If there are any documents that are defined or referred to in the shareholders agreement, in particular, those referred to in the warranties, then these must be provided at completion, for example, a copy of the business plan, the investor presentation, the management accounts or any due diligence reports.
Alongside the adoption of the revised articles of association, signing of the shareholders agreement, there are a number of other documents and actions required to complete the round. Drafting of these documents will normally form part of the scope of works for the law firm representing the investor, who is also taking the lead on the investment documentation. It may be part of your law firm’s scope to review these documents and actions.
A share certificate will be produced for each investor in the round, setting out the number of shares they hold, the class of share and the nominal price per share (often a penny or a pound).
Each share certificate is signed by director of the company and witnessed.
A board minute will be prepared that will approve:
The board minute should also:
The board minute is signed by the Chairman of the board.
This ordinarily takes the form of one document with two resolutions:
The document is signed by the existing shareholders of the company.
A disclosure letter is usually drafted in response to certain individuals and the company agreeing to provide warranties.
The letter sets out any information that relates to the warranties.
For example, the CEO may have provided a warranty that there is no outstanding litigation with any former employees. If there is any outstanding litigation, then this would be disclosed in the disclosure letter and referenced to that particular warranty. This ensures that the new investors are aware of these matters and provides legal protection to the warrantor, as the investors would not be able to make a claim against the warrantor for breach of warranty in relation to that particular litigation. If the outstanding employee case was not disclosed and were to come to light after the transaction, then the new investors may be able to claim for breach of warranty.
The disclosure letter is signed by the warrantors and the new investor(s), to confirm receipt.
Any documents that are defined or referred to in the shareholders agreement, in particular, those referred to in the warranties, must be provided at completion, for example, a copy of the business plan, the investor presentation, the management accounts or any due diligence reports.
The investor’s legal counsel will carry out a number of specific pre-completion searches:
Make sure that you obtain power of attorney for any key individuals that are unable to attend the completion meeting and are unable to sign remotely. It is surprising how often completions are held up by availability.
If the company has restructured as part of the investment, ensure that a bank account has been set up for the entity that will receive the proceeds. It can take time to put a bank account in place and this can delay completion.
If you are not familiar with some of the terms used in this resource, we recommend taking a look at our Understanding growth capital term sheets resource.
Once a term sheet is agreed and during the course of due diligence, investors will provide a first draft of the proposed shareholders agreement.
Part of the scope for your appointed law firm will be to review the proposed shareholders agreement and ensure that it reflects the terms agreed in the term sheet.
Also known as the subscription agreement or the investment agreement, the shareholders agreement sets out the commercial and legal terms of the round, including how the company and its investors will interact.
Unlike the articles of association, the shareholders agreement is not a constitutional document and therefore does not have to be made public. It may contain information and terms that you consider to be commercially sensitive and prefer to keep confidential.
Parties to the agreement will be:
It is typical for several drafts of the shareholders agreement to pass between both sets of lawyers before the final draft is agreed. We recommend staying close to this process so that you are aware of any points of a commercial nature and can provide your position. The term sheet is used as a guide, but remember that it is not legally binding and therefore it is possible to propose changes.
In negotiating any equity investment, it is important not to lose sight of the fact that you are entering into a long term partnership with the new investor, and not selling the business, for example. As a result, alignment is important and protracted negotiation on minor points may be damaging and could impact the likelihood of completion or a successful partnership.
Here are a number of key points that are often discussed specifically during negotiation of the shareholders agreement:
Warranties and warranty liability caps
The company and certain members of the management team will be required to provide warranties. The list of warranties is included within the Shareholders Agreement. It may be that additional warranties are added by the investor through the course of due diligence – particularly if any concerns are raised. It is important to understand what each of the warranties means and if there are any that you are not prepared to give, then ask your lawyer to propose a caveat, carve out, or to disclose certain information against those specific warranties in the disclosure letter.
Warranty liability caps set out the maximum amount of money the company or individual is liable to pay in the event that the investor makes a claim under the warranties.
Where this cap is set depends on the investor and each individual warrantor, but they are often a subject of discussion as certain members of management may feel uncomfortable about their liability.
There are a few guiding principles that investors use when proposing liability caps:
Investor consents
The shareholders agreement will set out any investor consent items, i.e. actions or matters for which investor consent must be sought.
This is necessary for minority investors who do not hold a controlling equity stake and therefore cannot exert this influence through their shareholding alone.
They require the ability to veto certain decisions in case they are excluded from them.
It is important to note that consent items are often those of key strategic importance to the company and its growth. The list is not intended to be an indication of the items that the investor wishes to veto, but instead the decisions that the investor would not want to be excluded from. They may be used as a guide as to decisions that should be discussed at board meetings.
The consents will likely include certain thresholds that should be set accordingly for your business.
Once all terms are agreed, the shareholders agreement is signed by the relevant parties and dated on completion of the transaction, and from then on becomes legally binding on the parties to it.
It is common practice in the US, and occasionally in the UK, for companies that undergo multiple successive funding rounds to have two agreements: a shareholders agreement and a subscription agreement.
The two documents essentially split the shareholders agreement in two – the shareholders agreement acts as an umbrella agreement while each subscription agreement governs a particular round.
This is designed to avoid the need to negotiate and draft an entirely new shareholders agreement each time a fundraise is undertaken.
The shareholders agreement contains the investor rights, such as information rights, warranties, investor consents and restrictive covenants.
The subscription agreement contains only the specific terms and mechanics of that particular round.
This approach can work well provided that the umbrella shareholders agreement is sufficiently sophisticated such that investors in subsequent rounds are happy to agree to their terms without significant amendments.
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:
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 the fundraise and to calculate specific figures for the legal documents, for example:
We have built an easy-to-use cap table template which encompasses an option pool (if needed), cash out (if needed) and the issuance of equity.
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:
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:
We recommend appointing a law firm with experience of equity fundraising to advise you on the legal documentation.
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, which may help to avoid misunderstandings and 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:
