Companies commonly raise capital by issuing new shares to investors. Normally, the company’s solicitor will prepare a draft share subscription agreement (SSA) based on the signed term sheet or initial discussions with the investor. The SSA is a principal agreement between the company and the investor because it sets out the terms and conditions of the investment transaction, including the class of shares, share rights, purchase price, warranties, and certain covenants of the parties.
What are the key terms of an SSA and what and when should you be negotiating them?
At a minimum, the SSA should contain provisions on:
- the number of shares to be issued.
- the class of shares to be issued (e.g., ordinary shares and/or preference shares); and
- the amount to be paid by the investor (or the subscription price per share).
If the company raises funding through crowdfunding platforms such as Seedrs or Crowd cube, these platforms will normally require that their standard SSA is used and appoint a nominee to hold the shares on behalf of the investors. The SSA will also set out the fees paid to the platforms which will be deducted from the amount raised.
If a new class of shares is issued to the investor with particular share rights (such as dividends, voting, etc), it should be written into the SSA, and the company’s articles should be amended to record the new share class.
When completion (or closing) occurs, the investor pays the money agreed to Company. Before this the investor would normally need to be satisfied about certain aspects of the company carrying out commercial, & due diligence. The investor may require specific conditions be met before completion, such as certain other documents are entered into (e.g., shareholders agreement or IP assignment) or the company achieving certain milestones or corporate structures agreed. These are commonly called ‘conditions precedent’ or CPs.
In many cases, there will not be any CPs at all. The more complex and high value the transaction is, the more CPs the SSA will likely have. The company’s and investor’s solicitors may agree on a ‘closing checklist’ to ensure that all conditions are met on or prior to closing. More complicated SSA may also include different requirements on signing and completion.
Investor may choose to waive certain conditions or require that they are completed post-closing depending on their assessment of risks related to the transaction. The parties may also agree on multiple closings in the SSA where the investor or investor group is willing to invest more funds at later stages.
The main purpose of warranties in the SSA is to give the investor certainty about the company in which they are investing. Generally, the SSA will contain warranties by the company and/or founders relating to:
- capital structure.
- authority to enter into the SSA;
- accuracy of information (i.e., the information given by the company to the investor is materially accurate).
Depending on the value and complexity of the transactions, the investor may request that a full legal due diligence process takes place whereby the company shall disclose information about its business to the investor’s solicitor for investigation. The investor may also seek more detailed warranties relating to the company in the SSA, e.g., accounts, assets, intellectual property, key contracts, claims or disputes, or any other matters that could materially affect the value of the shares being sold.
As the investor would normally seek wide-ranging warranties from the company to protect their investment, the company should consider the wording of the warranties carefully to make sure that they are not too wide or unnecessary given the due diligence process, thus inadvertently exposing the company to indemnities (see below).
The investor will normally require the company to indemnify them against any damages (including legal costs) which may arise from the company’s breach of warranties, breach or non-performance of covenants, conditions or other agreements made or to be performed by the company pursuant to the SSA. The indemnity may be extended to cover the investor’s representatives, employees, etc.
This provision can create burdensome obligation to the company, thus the company should assess the implications of this provision and/or minimise the risk of it being enforced against the company (e.g., by limiting or qualifying the warranties given by the company).
Certain investments may qualify for tax relief schemes such as EIS and SEIS. These may play an important role in the investor’s decision to invest in the company, therefore, the investor may require that the SSA includes provisions regarding this. The company should ensure that their undertaking is not too wide as the decision is ultimately made by HMRC, not the company.
The SSA should also contain provision requiring that confidential information shared between the parties shall not be disclosed except as agreed between the parties.
In conclusion, despite not being compulsory, the SSA is an important document in a share subscription transaction. It sets out the agreement between the company and the investor regarding the terms of investment, such as the shares to be issued, completion, warranties, and indemnity. Before concluding investment, an investor and company should both understand and negotiate whereafter the agreed m terms will form the SSA which is there to protect both interests and avoid disagreements in the future.