Whether you are sourcing seed investment or completing a series A funding, the final stages of a fundraising process are critical.
Once you have received your term sheets, you will likely go through a negotiation phase until the term sheet is agreed. Term sheets are not binding, but they form the foundation for the binding legal documentation ahead of an investment. So it is important to understand and negotiate your term sheet well.
Once you the term sheet has been agreed, your lawyers will draw up the transaction legal documents to close the round. This process will take iterations and the documents will be circulated between founders and investors and their legal advisors.
What are the main equity financing documents?
Fundraising documents can vary depending on round size and complexity. However the main documents tend to include:
- Funding term sheet: the non-binding legal document outlining the terms of the investment
- Stock purchase agreement (SPA): laying out the terms of the fundraise and outlining the number of shares and price paid
- Investor rights agreement: an agreement to provide certain rights to a specific investor. These could be voting rights, inspection rights, observer rights or rights of first refusal
- Articles of association: created when the company is incorporated. These lay out your company's constitution and defines responsibilities of directors and the board's and company relationship to shareholders
- Certificate of incorporation: a document issued by Companies House to all registered companies
- Disclosures schedule: a list of disclosures made against and in relation to representations and warranties, or containing information required by certain warranties
- Previous investor consent: outlines a range of issues (e.g. shares issuance, company sale, etc.) where consent from the investors is needed
- Preemption notice: prevents from selling shares to a third party before asking existing investors if they want to buy shares first
- Board resolution: resolution from the board of directors approving the funding round
- Shareholders resolution: resolution from shareholders in which they approve the issuance and waive pre-emptive rights
- SH01 form: a form filed with Companies House to give notice of the allotment of new shares
What to be aware of when drafting the legal documents?
You are not just negotiating for better terms, but also building credibility with the investor. If you accept a term sheet without due consideration, you will look careless. On the other hand, if you argue every minute point, that will create a negative image.
Show that you know what the most critical issues are for you and be ready to address them. An investor will understand what is important to you and will respect you for trying to strike a good and fair deal.
Your term sheet negotiations will be with the lead investor and at this stage they will cover key topics. The main topics tend to be valuation and investment amount, impacting price per share. You will also cover other topics such as capital structure and preferred stock, liquidation preference and distribution rights or discuss employee benefit plans.
A terms sheet only contains indicative guidelines based on which the fund is willing to invest. In order to close the fundraise, a series of legal documents will also be needed.
The 'best' term sheet will not always be the one with the highest valuation. It is important to assess each term sheet as a whole, reflecting on the other conditions highlighted in the document.
An investor partnership will last long and your investor's support will be invaluable in future financing rounds. Picking a trustworthy investor, with a strong reputation, can be a fantastic move for your business.