Are you a small business with a great idea looking to secure funds to help grow your business? Or are you a company looking to expand its operations and need the cash to get it done? You may then decide to look into raising capital by issuing shares in your company. However, before reaching out to potential investors, you should familiarise yourself with the relevant laws and investigate the different types of shares you could offer to those investors.
The investor has the higher ground during the bargaining process as they have the funds you need while you have to convince them to invest in your business. The type of investor you pitch to will likely be well-versed in negotiating favourable terms. Investing in fledgling companies is risky, so the investor will seek as much value and control as possible. Once you have found an investor, you will need to find a way to convert your negotiations into a formalised agreement. This article outlines three documents you will need to secure an equity investment for the capital raising process.
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1. Term Sheet
Suppose you have successfully delivered your pitch and attracted a potential investor. Now you are in the negotiations process of working out what they will get and how much it will cost them. In this case, you should keep track of these terms and put them into writing before drafting your long-form documents.
Some key terms you would find in a term sheet include:
- investment amount and round size;
- pre-money valuation;
- post-money valuation;
- share class (ordinary or preference shares) together with any specific rights attaching to that share class (e.g. anti-dilution protection or liquidation preferences);
- director/board observer appointment rights; and
- veto rights over critical business matters.
2. Share Subscription Agreement
Once you decide on the investment terms, you must arrange for the issue of the shares to the new investor. Thus, you will usually document the mechanics of the share issue in a share subscription agreement. This agreement documents what each party must do and when to finalise the investment.
Some key terms your share subscription agreement should specify include:
- the number of shares being issued,
- when you will issue the shares,
- the subscription price of the shares on offer,
- any conditions that must be satisfied before the shares are issued, and
- representations and warranties made by the company.
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3. Shareholders’ Agreement
Although a shareholders’ agreement is not required by law, it is critical to ensure your business is in the best position to continue with existing shareholders or begin a relationship with new investors. The shareholders’ agreement will bind the shareholders to a set of agreed terms that will reduce confusion and ensure all shareholders are aware of their rights and obligations to the company. The clauses you require vary depending on your business plans and what you agree to. Standard shareholders’ agreements will include binding clauses that will cover the basics of your business relationship, including:
- board composition and control;
- decision-making process;
- information rights;
- pre-emptive rights (i.e. the right to participate in any new issue of shares or any transfer of shares);
- confidentiality clauses;
- restraints of trade; and
- dispute resolution processes.
Furthermore, your agreement should explicitly state the rights and obligations of the shareholders. This minimises the likelihood of future disputes and ensures a set process that parties must follow to resolve any dispute if relationships break down. Additionally, this can reduce the possibility of costly litigation.
Why Do I Need These Documents?
Everyone starts a new business venture with high hopes that it will succeed. Therefore, people are less likely to dwell on the potential consequences of disagreements between parties.
The term sheet will ensure that both parties are aware of what has been agreed, reducing the possibility that one party will want to amend documents after drafting.
The share subscription agreement means that you can ensure the issue of shares only goes ahead once any pre-agreed conditions have been satisfied. It also ensures the share issue follows the correct sequencing.
Finally, the shareholders agreement will clearly set out the rights, obligations and powers of the shareholders. This prevents new shareholders from adjusting the company to best suit them and reduces the possibility of disagreement.
Key Takeaways
When you are raising capital, you want to protect your company and put your best foot forward to investors in the process. Having the correct legal documents in place is crucial to achieving this goal.
If you need help with these documents, our experienced capital raising lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Although it is best to implement a shareholders’ agreement early, it is never too late to have one drafted up. Again, get in touch with LegalVision’s capital raising lawyers if you need assistance.
Some investors will specifically request a share subscription agreement. You may opt for a shorter form share subscription letter where the investor does not. Unlike a share subscription agreement, a letter may not contain company or founder representation and warranties. It is, therefore, less risky for the company/founders. However, it is essential to note that larger investors and venture capital funds usually insist on using a share subscription agreement.
If you already have a shareholders’ agreement in place, you should consider using a deed of accession when taking on new investors. A deed of accession is a shorter document that prevents you from having to amend and re-sign your shareholders’ agreement each time a new investor invests in your company. Of course, this only works if the new shareholder is comfortable with the terms of the existing shareholders’ agreement and no changes are needed (for example, to reflect additional rights that they have negotiated as part of their investment).
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