When a startup starts raising capital, one of the key steps is to sign investor agreements. These documents can significantly affect the future of the company, its strategies, and its growth opportunities. However, for many entrepreneurs, the legal intricacies seem complex and confusing. In this article, we will analyze the main aspects of investor agreements that every startup should understand in order to avoid getting into an unpleasant situation and effectively develop its business.
When a startup starts raising capital, it is important to choose the right agreement structure. Different types of agreements may be suitable for different stages of business development and types of investors.
This type of agreement is often used when an investor provides money to a startup in the form of a loan with an obligation to repay, sometimes with interest. This type of agreement can be useful for startups that do not want to give up a share of the company at the initial stages, but are ready to return the money after a certain time.
Features:
Loan term: it is important to clearly define the repayment period, as well as the possibility of extension.
Interest rate: Often the rate can be linked to market conditions or set at a fixed rate.
Early repayment terms: It is important to specify whether the loan can be repaid early and under what conditions.
Conversion rights: Sometimes loan agreements contain a clause allowing the loan to be converted into equity in the event of certain conditions, such as a new round of investment.
This is one of the most popular options for startups. Under this agreement, the investor buys a stake in the company in exchange for funding. This option is well suited for earlier stages, when the startup is interested in capital and a willingness to share in future success.
Specifics:
Stake size: The exact percentage of the stake that the investor will receive for their investment is specified.
Company valuation terms: The company valuation determines how much money will be received for the sale of the stake. This can be an important point that affects the structure of the deal.
Investor rights: The investor may require certain management rights, including voting rights, the ability to appoint representatives to the board of directors, etc. Startup restrictions: There may be restrictions on what the startup can do without the investor's approval, such as making major decisions or entering new markets.
Convertible bonds are debt instruments that an investor can exchange for equity in the company at a future date. This is a popular form of contract for early-stage startups when the startup needs to raise capital quickly but the current valuation of the company is not yet determined.
Characteristics:
Conversion into shares: The investor can exchange their bond for shares in the company at a pre-agreed price in the future or depending on the terms of a new round of financing.
Discount or cap: Convertible bonds typically include a discount on the price of the next round or a maximum price (cap) at which the bonds will convert.
Interest rate: The bonds may have an interest rate that is paid until the moment of conversion.
This type of contract is often used when a startup raises funds from venture capital funds. Unlike angel investors, venture capital funds often have more complex terms, including various measures to protect their interests.
Features:
Interest protection mechanism: the agreement may include anti-dilution protection conditions, requirements for compliance with financial and operational standards.
Exit mechanism: the terms of the venture fund's exit may be detailed, including the sale of the company, an IPO, or a buyout of shares.
Investment conditions: venture funds may require the achievement of certain indicators, such as revenue growth, before providing additional funds.
Sometimes, an investor may act not only as a financial partner, but also as a strategic partner who brings additional resources, such as access to markets, technology, or industry connections.
Characteristics:
Common goals and strategy: In such agreements, it is important to detail what strategic goals both parties have set for themselves.
Additional resources: For example, an investor may provide a startup with access to its network of contacts, infrastructure, products, or technology, which can significantly accelerate the development of the business.
Rights and obligations of the parties: It is important to clearly spell out what responsibilities each of the partners has, as well as what risks they share.
Preferential terms
A preferred share agreement is used when an investor receives shares in a company that provide him with certain advantages over ordinary shares. This may include the right to a priority refund in the event of a company liquidation, additional votes at shareholder meetings, and so on.
Features:
Liquidation Preferences: An investor may have the right to receive their investment before the funds are distributed to other shareholders.
Voting and Management Rights: Some preferred shares give the investor more voting rights or other conditions that allow them to influence decisions.
Conversion to Common Shares: In some cases, preferred shares can be converted to common shares under certain conditions.
It is especially important for a startup to understand the conditions for the investor to exit the business. This point should be agreed upon in advance to avoid conflict situations in the future.
Exit through the sale of the company. In the case of a business sale, the investor can receive his share of the proceeds. However, it is important to understand what terms of sale are provided for in the contract and how this affects the distribution of funds.
Exit through an IPO. Some investors may be interested in the opportunity to sell their shares through an initial public offering. This usually applies to larger startups, but it is important to provide for appropriate conditions.
Exit through the sale of a stake. If the company does not intend to enter the market, the investor can sell his share to another investor or partner. It is important to establish the rules for the sale of a share in advance to avoid blocking the deal.
It is especially important for startups to protect their interests in order to avoid infringement of rights or deprivation of control over the company. Here are several mechanisms that can be included in contracts:
Anti-dilution. This is a mechanism for protecting against dilution of the startup's share in the event that the company attracts additional investments at a lower valuation. It helps to maintain the percentage ratio and protect the interests of the initial investors.
Influence on strategy. It is important to stipulate what level of control or influence on the company's strategy the investor receives in order to avoid situations where decisions are made without taking into account the interests of the founders.
Preferred terms. Sometimes investors require that in the event of liquidation or sale of the company, they receive their money first (for example, priority return of invested funds). It is important to take this into account when concluding an agreement in order to minimize risks for the startup.
Properly negotiating with investors is a key part of successfully raising capital. Here are some tips for startups:
Be prepared to compromise: the terms offered by the investor may be tough, but it is important to remember that negotiations are a process. Sometimes reasonable concessions can lead to a more favorable agreement in the long term.
Get professional legal help: it is important not only to understand the terms of the agreement, but also to interpret them correctly. Do not hesitate to contact lawyers who will help you understand the intricacies of contractual terms and avoid mistakes.
Plan for the future: do not limit yourself to current terms. Think about the future growth of the company, possible further rounds of investment, and how your agreements can affect these processes.
Agreements with investors are not just formalities, but strategically important documents that affect the development of your business and relationships with partners. Knowing the key points and the right approach to negotiations will help you not only attract investment, but also create a solid foundation for the long-term success of your startup. Do not forget that competent legal support and strategic planning are the key to successful cooperation with investors and the future growth of yGoudabliss.
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