INVESTMENT AGREEMENTS WITH START-UP FOUNDERS KEY CLAUSES

Types of Investment Agreement and its Clauses

Business Nov 22, 2020 0 Add to Reading List

INVESTMENT AGREEMENTS WITH START-UP FOUNDERS KEY CLAUSES

Types of Investment Agreement

Shareholder’s Agreement (SHA)

It is the agreement that is made between the shareholder and the company. It specifies the clauses of the deal and the rights and privileges which is enjoyed by the investor.

Share-Subscription Agreement (SSA)

It is an agreement that is made between the shareholder and the company when the shareholder invests by subscribing to new shares that are when new shares are made available to the shareholder.

Share-Purchase Agreement (SPA)

It is an agreement that is made between an already existing shareholder and an incoming shareholder who is taking the shares from an existing shareholder.

Key Clauses in an Investment Agreement

Types of Securities

Equity Shares

For investors, equity shares are the ones with a lot of uncertainty and risks and it’s more when someone is investing in an early-stage start-up. But it gives some rights to the investor like ownership, voting rights, and profits in the form of dividends. And when the company grows and prospers the equity shareholders benefit the most due to the share appreciation.

Preference Shares

This type of shares doesn’t involve voting rights in the company. But are paid the dividend to the equity shareholders. And in the case of winding up of the company, preference shares are paid in priority to the equity shareholders.

Hybrid Security

These are very much in demand nowadays. They enjoy the characteristics of both equity and debt/preference shares.

Clauses to ensure Protection to an Investor

An investor usually demands the following rights that make sure about the protection of its investment.

Veto Right against Fresh Issue of Shares

An investor may have a veto right against the fresh issue of shares. This means that the company before making fresh shares available has to take permission of the investor. This ensures that the investor has control over the capital structure of the company.

Pre-Emption Right

In case of a fresh issue of shares by the company, this right permits the existing investor to proportionately subscribe to the new shares. It allows the investor to protect its shareholding percentage, which can also decrease in case of a fresh issue of shares.

Anti-Dilution Right

If the company issues fresh shares at a lower rate in the next round of funding so that will be detrimental to the interest of the investor who had invested in the earlier round of funding at a much higher valuation. In this case, anti-dilution right requires the company to issue new shares to the investor. This one is the essential right to protect the interest of the investor. But enforcing such a right in the case of equity shareholding might not be that easy as Indian law does not permit free shares to be issued.

Clauses to ensure Founders Commitment

Such clauses may include:-

Founder Lock-In
Employment Agreement

Non-Complete and Non-Solicit Clauses

Non-Compete Clause

This is like you are investing in a startup by trusting the idea of the founder but after some time the founder sells its share and exists from the startup and opens a new business. So obviously the previous startup where you have invested will fail, this is where an investor asks for a non-compete clause that limits the founder from engaging in another business for a specific period of time and after which they exit from the startup.

Non-Solicit Clause

This clause restricts the founders from soliciting the employees, suppliers, or clients of the start-up with them when founders themselves an exit from the start-up.

Keeping a Watch on the Company and the Matters needing Consent of the Investor

Board Representation

An investor generally asks for a board representation, which typically means he has the right to nominate his representatives to the board of directors of the investment company. Such representatives act more like observers, instead of participating in the day to day activities of the company.

Affirmative Voting

A Shareholders Agreement (SHA) contains a list of reserved matters which contains issues such as issuing new shares, availing the loan, change in directors, etc. These matters need affirmative voting, meaning thereby, such matters need the consent of the investor.

Information Covenants

The investor cares about the performance of the company that is why it needs periodic information related to the company’s performance, being given to them.

Exit Clauses

The investor invests in a company with having a certain aim in mind. But what if it doesn’t work out? That is why for such situations an investor likes to have an exit option in certain circumstances open.

Following Clauses should ensure Exit Rights of an Investor-

Breach of Terms
Material Adverse Effect (MAE) / Material Adverse Change (MAC)

Representation and Warranties

This clause refers to a statement of fact related to the company, which is said to be true. Warranties are taken by the investors from the company on the basis of the issues taken up by the advisors of the investor in the due diligence report.

Indemnities

These are taken from the company in a situation when it violates specific warranties. This means in case of breach of warranty the investor needs the company to indemnify the investor.

Dispute Resolution and Governing Law

Dispute Resolution

This clause needs the parties to try to settle the matter of dispute in a friendly way and if it doesn’t work out then it may proceed to arbitration and court.