What issues will we need to negotiate into our key investment documents when seeking venture capital investment?

Technology start-up companies are an attractive prospect for investors due to their high growth potential, and venture capital investment in companies within this industry in the UK was at an all time high last year. 

When agreeing on the terms of the investment, there is a balance to be struck between the investors having involvement and oversight of the decisions being made within the business and ensuring its growth, and those running the business retaining a sufficient degree of freedom to operate their company and run it on a day-to-day basis without interference. 

Two of the main documents which will be prepared to govern this are the company’s Articles of Association and a Shareholders’ Agreement, within which will be the provisions setting out how such a balance will be achieved. These documents will often be heavily negotiated and the below are examples of some key provisions which founder shareholders seeking investment will need to be prepared to negotiate with their potential investors:

1.    Board structure

Often investors will want to remain close to the business and will require the opportunity to appoint a director of their choice to the Board. It is often a condition that a board meeting of the company will only be quorate, and decisions can only be made by the board, if that director is present.

2.    Matters requiring investor consent 

Certain key company decisions will require a certain percentage of shareholders to agree. Depending on how much equity the investors will receive on their investment, this will sometimes mean that they won’t have a high enough stake in the company to influence the outcome of these decisions, which could have a monumental impact on the value of their investment. 

It is therefore common place for the investors to insist on a list of agreed issues on which decisions can only be made if they agree, to ensure that their investment in the company is protected. Some examples of the decisions which could require their consent are:

• Appointing a new company director;
• Allotting any new shares; 
• Declaring any dividends; 
• Incurring any significant expenditure; and
• Accepting an offer to sell key assets of the company.

3.    Enhanced voting rights

Investors acquiring a material percentage of equity will very likely want to ensure that certain events will trigger the shares held by the investors to have ‘weighted’ voting rights, effectively allowing the investors to take control of the company.

Often this will be seen as a last resort for the investors, and is only done in order to safeguard their investment. 
It may be necessary to negotiate the events upon which such enhanced voting rights are triggered. Examples of such events include:

• Where the company breaches the requirement for ‘investor consent’ set out above;
• Certain critical individuals terminating their employment with the company; and
• A failure to pay dividends on the shares held by the investors.

4.    Leaver provisions

Often, the investors will be making an investment on the basis on the team who are in charge of growing the company, or, particularly within the tech sector, the individuals behind the development and delivery of the company’s product base and intellectual property. They will therefore want to incentivise those people to stay (or, rather, de-incentivise them to leave.) 

If any such individual holding shares in the company does leave, it is likely that they will fall into either a ‘good leaver’ or ‘bad leaver’ category (pursuant to the terms of the Articles of Association and/or the Shareholders’ Agreement), depending on the circumstances of their departure. Such categorisation will affect whether they are allowed to retain any of their shares or the value they will receive if they’re required to transfer them back to the remaining shareholders or the company itself.