The signing of an investment agreement is a significant stage in investing in new technologies, and takes place immediately after the negotiating and signing of a term sheet and the conducting of a due diligence by an investor. This is because the aim of the founders and creators of start-ups is to obtain a source of funding for the development and implementation of their project, whilst investors are seeking to make a profit on their new investment.
Investment agreement: binding nature
Investment agreements are a formal reflection of existing discussions between the parties planning to set up a joint venture.
In practice, such discussions are usually held between the founders of a project (startup) and investors. Private or professional investors or funds, including venture capital funds.
Such agreements, unlike term sheets, are binding in nature and represent a formal commitment to a specific action or inaction by the parties, e.g. for start-up founders not to engage in activities that compete with the activities of a company in which a capital investment is made. The documentation may also include exemptions from such a prohibition.
Joint venture or change in existing shareholding structure
Investment in a start-up can be made via:
- a joint venture involving the creation of a new entity. This is an initial stage where the founders’ only asset in attracting investment partners may be an idea, a specific business plan and an experienced team who will remain involved in the project even after the company has been registered and the investment made.
- an investor joining an entity existing in the market as part of an increase in the company’s share capital and taking up newly issued shares offered to the investor. The implementation of such a scenario will usually result in the dilution of the founders’ existing ownership package, unless they also decide to participate in such an increase by making a cash (or in-kind) contribution in exchange for additional shares issued.
Start-ups and investors – investment agreement provisions
Virtually every investment agreement contains standard contractual clauses, i.e.:
- Drag along (the right to force the remaining minority shareholders to sell their shares) – usually granted in favour of either an investor or a majority shareholder.
- Tag along (the right to join in the sale of shares) – usually granted to minority shareholders or start-up founders.
- Lock-up – a prohibition on the sale of company shares within a certain period (usually during a cooperation period) or without an investor’s consent.
Key Performance Indicators (KPIs)
Investment agreements also include provisions that take into account the specificities of a particular industry and of the company itself, both formal and business-related.
A good example may be Key Performance Indicators (KPIs), which set out the conditions that must be met before the next investment tranche is released or the founders exercise the option to buy back an investor’s shares.
In the IT industry, such key conditions may include, but are not limited to, the completion of the design and prototyping phase, the construction and delivery of a platform or application for testing, the creation of a product within a certain timeframe or its sale at a specific level.
It is important to bear in mind that jointly negotiated contractual provisions, including a prepared business plan and developed KPIs, can ensure a successful cooperation for the parties for several years.
Therefore, it is worth paying a little more attention to their content and preparing such provisions that will be satisfactory to both parties in a joint venture transaction.
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