Investment Agreements
For new and developing businesses, fundraising is often a critical if exciting key stage of the process. If and when investors are found, an Investment Agreement is an important document that should protect and provide guidance to all parties, including the business, the shareholders and the investors. In this article, we take a look at the key components that need to be included in such an agreement.
What is an Investment Agreement?
An Investment Agreement is a binding contract between the investor and the company (including the shareholders). It sets out the terms and conditions of an investment. A well-drafted Investment Agreement will protect the parties against risk and can also help ensure the success of the investment. Investment Agreements are common in early-round venture capital investments.
What’s the difference between an Investment Agreement and a Shareholders Agreement?
An Investors Agreement sets out the terms and details on which the investment is made whereas a Shareholders Agreement sets out how the company will be managed.
What are the main components of an Investment Agreement?
There are a number of essential elements to an Investment Agreement. These include:
- The parties
- The investment detail
- Rights and responsibilities
- Warranties and restrictive covenants
- Confidentiality
- Exit
- Costs
The parties
The parties to an Investment Agreement should include the investor, the company and the shareholders. The agreement should also provide for future shareholders to be bound by the terms of the agreement. If there are large numbers of minority shareholders, it may not be possible to include them all.
The investment detail
The agreement needs to specify the amount being invested, whether the investor is going to receive a stake in the company and the terms of that investment. This should include the subscription of shares and an agreed price per share.
If and where the investment is going to be paid in tranches, it is important that details of terms and conditions to be met are included. For example, investors may require certain milestones to be met before payment and these milestones can include anything from completion of a business plan and management accounts to the development of a particular product.
This means that for each payment stage, careful thought needs to be given to what conditions are appropriate, and what needs to be done when the conditions are met, for example, issuing shares and certificates to the investors or appointment of the investor director to the board of directors.
Rights and responsibilities
Investors are likely to seek certain rights in return for their investment such as voting rights, board representation and rights to information. Agreeing and clearly defining the extent of these rights is essential. There are also legal requirements to be met (such as a declaration of any conflicts of interests).
Investors may want the right to either ‘observer rights’ in respect of the board of directors or they may require the right to appoint a director. They will usually seek at least a minority interest and may require more and may want a contractual right to prevent shareholders taking key decisions without their consent. Once again, the detail of this will need to be carefully negotiated and agreed and is likely to cover such things as the right to vary shareholder rights, issue or grant options over the company’s securities, and the removal or appointment of a director, etc.
The agreement should also stipulate the level of control and input an investor will have when it comes to important decisions and their access to management information.
There may be a requirement for management to produce management accounts, audited accounts and financial models.
Warranties and restrictive covenants
The company or its founders will usually be required to provide certain warranties. Warranties are often sought and provided in respect of performance, liabilities, contracts, tax and IP ownership. Consideration should also be given to whether any limitation of a warranty is appropriate such as time or financial limitations (such as a cap on individual liability of directors or management).
Investors may also wish to negotiate fixed damages payable in the event of a breach of the warranty in order to simplify the claim process.
Restrictive covenants may also be required to prevent the company, its founders or key personnel from competing with the business when or if they cease to be involved with the company.
Confidentiality
There should be a provision that sensitive commercial information will be kept confidential. The agreement should also deal with press and public announcements and disclosures.
Exit and dispute resolution
An exit strategy should be clearly articulated and include what happens to the exiting party’s shares, what happens in the event of an unresolved dispute or insolvency or if the investor simply wishes to cease investing. To this end, it is also good practice to include a dispute resolution framework.
Costs
It is usual for the company to pay the investors’ reasonable legal and due diligence fees or a proportion of them. This should also be set out in the Investment Agreement.
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