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Raising capital is something most fast-growing startups or companies will have to do to stay competitive. This is because you need capital to pay for growth, whether this is more tech development, better marketing, or a greater provision of products or services. This article sets out the key legal documents you will need to have in place when bringing on investors.

1. Term Sheet

A term sheet sets out the commercial terms of the capital raising. The document is used for the initial negotiations between your company and the investors. Its main function is to ensure you all agree on the most important aspects of the transaction and that the investor wants to progress to the next stage of capital raising.

A term sheet can also be referred to as heads of agreement or a memorandum of understanding.

A term sheet usually contains important terms such as:

  • the amount of money to be invested;
  • the pre-money valuation of your company;
  • how the shares owned by the founders will vest;
  • whether the investors will have a seat on the board of directors;
  • what influence or control the investors will have in the decision making;
  • anti-dilution rights and protections for the investors; and
  • any dividend policy.

The Benefits of a Term Sheet

Even though the term sheet is an optional document, it helpfully provides investors with an overview of the investment opportunity. This is important where your investors are sophisticated, such as a Venture Capitalist, so they can quickly see all the key terms.

Rather than accepting your term sheet, an experienced investor may provide you with their own term sheet setting out their terms for investing in your business. Therefore, it is crucial you have an understanding of the key terms of a term sheet.

A term sheet is evidence of serious intention to fulfil a transaction but is not legally binding. Some provisions, such as certain aspects of confidentiality, may bind you and your investors. Other terms, such as the size of the investment, generally will not bind you. For example, if someone intended to invest $500,000, but later became uncomfortable with the investment and changed their mind, they are not legally bound to invest the $500,000. They are however legally bound to not compete with your company.

2. Share Subscription Agreement

You will then need to formalise the term sheet’s key details by making each investor a share offer. There are different ways to do this but sophisticated investors will generally require a Share Subscription Agreement. This typically stipulates:

  • how many shares your company will be issuing;
  • whether the shares are subject to specific conditions, such as vesting;
  • the subscription price of the shares;
  • when the company will issue the shares;
  • investor representations and warranties (for your benefit); and
  • companyand sometimes founderrepresentations and warranties (for the investor’s benefit).

Warranties and Representations

Warranties and representations are statements from the company or founders the investors are entitled to rely on when entering into the transaction. These help investors manage the risk of investing in your business. Examples of representations and warranties include statements such as:

  • the information the company has provided is complete and accurate;
  • the company owns all relevant assets required for the business including intellectual property; and
  • the company is not currently or about to be involved in court proceedings.

A Subscription Agreement can be a fairly simple agreement with limited warranties and representations. Alternatively, the document may be a more comprehensive agreement with more extensive warranties and representations from your company. As company warranties benefit the investors, it is typically in the interest of your company to try to minimise the extent of the company warranties. If you are raising early funds, it may be possible to use a simple share subscription letter. This is a shorter document containing key terms of the investment but excludes warranties and representations.

3. Shareholders Agreement

If your company lacks a shareholders agreement, you can either:

  • draft a shareholders agreement before investors join your business; or
  • negotiate a shareholders agreement with the investors based on the term sheet.

A company can draft and sign the shareholders agreement beforehand and present this to investors as a final agreement. Experienced investors will, however, often seek amendments to the shareholders agreement. Overall, the shareholders agreement sets out the roles and responsibilities of the shareholders and the company’s directors. The document covers matters such as:

  • directors duties;
  • organisation of board and shareholder meetings, including voting rights;
  • issuing of new shares;
  • sale of existing shares;
  • ways to solve board deadlocks; and
  • dispute resolution.

4. Deed of Accession

If your company already has a shareholders agreement, new investors will need to agree to the shareholders agreement explicitly. They could sign the original shareholders agreement but this means that every shareholder would need to re-sign it.

A better approach is to have new shareholders sign a Deed of Accession to the shareholders agreement. A Deed of Accession is a short document new investors can agree to, stating they will be bound by the existing shareholders agreement. A Deed of Accession saves you from having to amend and re-sign your shareholders agreement every time a new investor invests in your company.

Key Takeaways

When raising external capital for your business, it is crucial to have the right legal documents in place to protect your company and its value. The primary documents that you will need are a Term Sheet, Share Subscription Agreement, and a Shareholders Agreement (possibly combined with a Deed of Accession). If you require assistance drafting or reviewing these documents, call LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.

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