As a practice we have witnessed many ups and down in establishing and scaling businesses and the pandemic has certainly shaken up the market place these last two years. However, overseas investment , the change in business offerings, especially in tech, during this period has seen a growth in quality , quantity and success. The UK has, in our opinion, demonstrated resilience during COVID-19, and the UK economy appears to be bouncing back and retaining its appeal for investors across the world.
This article examines some of the key legal considerations when trying to raise capital for your business in line with the current market place as we have experienced.
Look at all your options
Equity financing is usually the first step many take first, without exploring the different options which may be available. It maybe seen as the easy option or what everyone is doing, but this is not necessarily the case for every business. Equity financing you are giving away a share in your business; maybe control and welcoming in a new stakeholder who has legal rights and to whom you owe legal responsibilities.
Founders often neglect to explore other financing options, which can be used simultaneously or as an alternative: such as debt , these can be with high street or commercial lenders which are displaying competitive commercial rates presently or maybe you qualify for a grant (essentially free money) as the UK offers many. Businesses should also consider whether there is R&D tax relief available which can result in a cash payment based on funds you have spent on R&D. In addition, founders should explore whether there is any Covid-19 support available to them or low interest debt options. There may also be means of employing support , without large salary expenses, such as option agreements which can also address immediate needs of the business.
Founders should be mindful that equity is not the only possibility and may not be the best fit for their business. However, that is not to say it should not be explored as often this is complimentary to the other options or for others the most suitable option.
Look in the mirror and be prepared
It is important that you look carefully at your business from the perspective of any potential investor. As part of any investment process you can expect a degree of due diligence. This often takes the form of legal, financial and commercial due diligence. The extent and volume of due diligence does depend on the amount being invested and the status of your company. It is however important to try and identify swiftly potential areas of concern. So take a look in the mirror and be prepared with concise , executed documents, answers to their tough questions and don’t forget above all to impress upon them your unique selling features , experience and passion.
Areas of legal due diligence can be summarised as being able to respond and address the following key areas:
- do you have signed and suitable contracts with all members of staff employed or otherwise. Do these have suitable confidentiality clauses; protects the businesses intellectual property and hold suitable restrictive covenants?;
- do you have signed contracts or valid terms and conditions with all customers and your suppliers?
- do you have an agreement regulating the founders, a shareholders agreement is essential for any business and them coming in as a stakeholder?
- have all shares been properly allotted and transferred?
- have you filed everything at Companies House that should have been filed?
- has someone been promised something from the business , such as shares, which isn’t in writing or reflected at Companies House?
- is there any dispute or litigation or investigation or any risk of the same?
- who owns the intellectual property of the business and how can you prove this?
- have you got any consent or license or regulation you need to sell your product or service?
- have you got a commercial property? Have you got a commercial lease in place or agreement to use the space?
- have you considered Data Protection carefully ?
- have you registered and protected your IP?
This is just a taste of the legal questions and documents that could be requested from you , that should be carefully audited ; updated and executed to protect the business
Is it the right investor/shareholder?
There are many different types of investors and each fit different types and scales of businesses. Depending on the size and stage of the business this may be venture capital, private equity, angel investors, trade investors ,passive SEIS investors or friends and family.
Founders sometimes neglect to consider whether the potential investor is a good or suitable fit for the business, although we do of course appreciate why. However, we would encourage all founders to carry out their own level of due diligence on any potential investor. By selling shares in your business to someone you are creating legal rights and obligations to that shareholder. With any business there are the inevitable hard times and difficult conversations. Having a suitable investor who is a good fit for your business makes those conversations a bit easier. It doesn’t dilute your obligation or legal duties not to unfairly prejudice them or act in breach of your fiduciary duties but it may make it a bit easier to address and remedy.
Do they understand your business or products ; could you ask them for assistance to scale or additional monies if necessary ; do they have the qualifications , experience or contacts they profess and what do they want from you?
Some of the due diligence you should be doing on any potential investor and questions you should be asking are:
- what are the investors exit plans? Are they aligned to yours?
- what are their and your expectations of a return?
- what other companies are in the investor’s portfolio
- what is the impact or sector of the fund?
- how involved does the investor want to be?
- how experienced is the investor?
- do they benefit from EIS have you considered this ?
- what demands are they making ?
- will they want you to sell and if so when?
The documents you can expect to receive as part of an investment round include:
A subscription agreement or investment agreement. This regulates the terms upon which the investor is putting the funds into your business. This is likely to include warranties or promises about the business and your company so these need to be carefully scrutinized;
A shareholders agreement. This regulates the high-level operations and running of the business. It governs the relationship between the shareholders. This document typically includes ‘reserved activities’ or ‘investor consents’ which are the list of activities that the company can and cannot do without the consent of the investor. This is where you negotiate
A disclosure letter. This deals with specific disclosures against any warranties so you declare anything required so its not later held against the company , as it was on the table.
A cap table detailing all relevant shares
You may also receive updated service agreements (employment contracts) for the founders (directors) governing their role in the business and usually include provisions on payment and expectations on services.
The legal documents for an investment round can be intimidating, these are usually lengthy and typically contain complex terminology. What is vital, however, for any founder is to ensure that the documents work for them and fit their business. The agreements are worthless if they are unrealistic for the business.
A founder should familiarise themselves with each and every clause and be confident that they understand exactly what they are agreeing and the impact on them and the business.
The key to a perfect pitch is being prepared ; transparent and the business plan figures , projections and statement supported by evidence when requested. However, never underestimate the selling power of the teams experience, qualifications and passion as ultimately the investor is giving its money to you.