If you are not familiar with some of the terms used in this resource, we recommend taking a look at our Understanding venture capital term sheets resource.
Once a term sheet is agreed and during the course of due diligence, institutional 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:
We have prepared an example shareholders agreement in partnership with Charles Russell Speechlys, a leading private equity law firm, which you may find helpful in understanding how these terms are typically drafted. This can be downloaded above.
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.
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:
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.
