Are you a fledgling company with a great idea that is 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 raise capital by selling shares in your business. But before reaching out to potential investors, you should familiarise yourself with the relevant laws and investigate the different types of shares available.
Selling equity in your business is a pretty big deal – you’re handing over a share of your business’ potential to a newcomer who hasn’t taken the same risks or put in the same effort as you did to get started. You could be raising funds through friends and family. Once you start to require larger sums, however, you are likely to look to angel investors or professional investors.
The newcomer is in a relatively strong position during the bargaining process as they have the money you need while you have to convince them that you’re the person with the business that they want. The type of investor you’re likely to pitch to will be well versed in negotiating favourable terms. Investing in fledgling companies is a risky business so each investor will be pushing for as much value and control as you’re willing to give them. Once you’ve found an investor, you will need to find a way to convert your negotiations into a formalised agreement. Here is a list of three documents that you’ll need during the process of securing equity.
1. Term Sheet
Congratulations! You’ve successfully delivered your pitch for *insert the latest cool idea on the market*. You have hooked a potential investor and are in the process of working out what they’re going to get and how much it’s going to cost them. Sounds like you’ll need to keep track of these terms and reduce them into writing before drafting your documents. As the name probably suggests, a Term Sheet contains exactly that – terms. The Term Sheet should include information such as the valuation of your business and the rights associated with share ownership. This will provide a clear and concise framework for the documents you’ll get drawn up once all parties are satisfied with the terms on offer. By ensuring all parties are aware of the agreed terms before the sale goes ahead, you can save time and money by reducing the likelihood that additional negotiations and/or redrafts need to take place before finalising the documents.
2. Share Subscription Agreement
Once you’ve decided on the terms, you’ll need to arrange for the transfer of the shares to the new investor. If you’re raising funds for a particular project, you may want the shares to vest if certain conditions are met. For example, if you are looking to raise funds for a particular project, a Share Subscription Agreement can establish the total amount that must be raised from all investors before the shares can vest in the new owners.
3. Shareholders’ Agreement
A Shareholders’ Agreement, although not required by law, is critical to ensuring your business is in the best position to continue a relationship 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 in your Agreement can vary depending on your business plans and what you’ve agreed to with your investors. Standard Shareholders’ Agreements will include binding clauses that will cover the basics of your business relationship including:
- Shareholder voting rights;
- The power to appoint directors;
- Confidentiality clauses;
- Restraints of trade; and
- Dispute resolution processes.
More complex clauses can be added to a Shareholders Agreements depending on your business’ needs. For example, clauses that cover what happens to the shares vested in someone that leaves your company.
Your Agreement should explicitly state the power given to your shareholders and agreed to by all parties. This can prevent a new shareholder from diluting your shares or appointing directors that will only represent their best interest. It will also ensure that there is a set process that parties can follow to resolve any dispute if relationships breakdown. These all protect your business and reduce the possibility of costly litigation.
Why Do I Need These Three Documents?
Everyone starts a new business venture with high hopes that it’ll succeed and are less likely to dwell on the potential consequences of disagreements between parties. Independent of the outcome, these three documents will place your business in the best position to move forward.
The Terms Sheet will ensure that both parties are aware of what has been agreed to – reducing the possibility that one party will want to amend the subsequent documents after they’ve been drafted.
The Share Subscription Agreement means that you can ensure the sale of your equity only goes ahead once you have satisfied the purposes of raising the money (i.e. have you found enough investors and raised enough money).
The Shareholders Agreement will ensure that the rights, obligations and powers of the shareholders are clearly set out. This can prevent your new shareholder adjusting the company to best suit them and also reduces the possibility of disagreement as everyone is aware of where they stand. The benefits of having an agreed dispute resolution process can also save both parties significant time and costs in future if you and your investors no longer see eye-to-eye.
If you have any questions about raising capital for your business, and the documents you will need, let our startup lawyers know.