Many businesses need investment, whether this is to develop their products, launch into the market place, toexpand or move into new market places.
The most common routes for taking investment is selling equity (company shares) and taking bank loans. Whilst these are well-known they are not without their pitfalls and obstacles.
If your business is seeking investment then it is essential that youget yourself and the business investment ready. The most important thingwhen looking for investmentisbeingarmed with all your options, understandingwhatyouwant and also what you need to put in place.
The pre-investment stage
Before you embark on seeking investment it is important that you and your co-founders decide on whether you are looking to give away equity in your company or whether you are looking for debt financing.
You also need to decide what type of investor you are looking for, be this a hands-on angel or an investor wanting no active involvement in the business, driven only by tax relief or an institutional investor or venture capital fund.
It is important that you have these difficult discussions with your co-founders at an early stage so all your views are aligned. Whatever you decide should be reflected in your co-founders agreement.
You need to be clear on how any investor will be able to get a return on their money. This should be made very clear within your business plan.
We also suggest a clear exit strategy be agreed between co-founders at the outset and reflected in a clearly drafted co-founders agreement.
If you do decide that you would want an equity investor, you next need to determine how much control are you willing to give away and whatlevel of control you want to retain.
Most founders want to be able to operate their business on a day-to-day basis, without having to seek the approval of their investors. For many the loss of control is one of the biggest disadvantages in selling equity stakes.
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Many investors want stringent levels of control where their consent is required before certain decisions can be made or auctioned.
We have also seen situations where the founders of a business have been voted out of the company by investors, been frustratingly unable to move their businesses forward and have been driven out due to changes.
It is during the pre-investment stage that you also need to value your business. We are often asked by business owners how they shouldvalue their business and how they canpredict what it may be worth in the future. To do this properly can be an expensive and time-consuming exercise and there are actually manyways to value a business. What you do need to know is that any investor, is going to always go with the one which values the business at the lowest possible amount.You also need to be able to justify any valuation that you put on the business with clear evidence.
At this stage we also suggest you undertake pre-due diligence?on the business. This involves looking at and putting in order what an investor would expect to see as part of any due diligence exercise.
This means that once you are in advance discussions with an investor, you can swiftly provide them with any information they request.
Not only does this project a professional image of the business but it will protect the valuation and not give the investor undue cause to reduce its proposed investment.?
At this stage we also suggest you undertake pre-due diligence?on the business. This involves looking at and putting in order what an investor would expect to see, as part of their due diligence exercise.
This means that once you are in advance discussions with an investor you can swiftly provide them with any information they request.
Not only does this project a professional image of the business but it will protect the valuation and not give the investor undue cause to reduce its proposed investment.
Documents that we would expect to have in place include a co-founders agreement, properly executed employment contracts for all staff, consultancy or free-lance agreements where appropriate, proof that the company owns all intellectual property that it purports to own, director service agreements, a comprehensive business plan, properly comprised company resolutions and accounts.
Once you have located a suitable investor interested in investing in the business it is important that you understand the investor terms as well as their objectives.
Often the key aspects of the deal will be set out in a term sheet. Once the term sheet is approved you can expect to receive the long form agreements.
You should not sign the term sheet before taking advice from your professional advisors including your lawyer and accountant.
Further before signing any of the long-form documents it is important that you carefully review all of the agreements and have these reviewed by your professional advisors.
We have seen agreements which contain clausesthat permit investors to remove the founders, have put unrealistic and excessive obligations on the founders, investors be permitted to take founders shares, restrict the founders from being able to run the business, be able to block a sale of the business, have anti-dilution clauses for the investors, have unfair bad leaver clauses, be able to install expensive executives with a salary determined by them, insist you change your trusted advisors and even contain terms offering discounted services to them.
Further investors often ask for a period of exclusivity on the deal. Whilst this may sound reasonable, the effect is that you in turn limit your negotiating position.
One of the strongest positions is being able to walk away from the deal or take alternative investment. By offering exclusivity you limit your ability to start a bidding war for investment.
It is important that you meet with different advisors and explore all your options, be this debt or equity investment. Some of the different options include:
Bank loans (which may have a low interest rate)
Debt financing such as corporate bonds, secured or unsecured loans
EIS/ SEIS as tax incentives for investors
Joint venture agreements
Government and social grants
You should always remember that your advisors are just that; advisors. It is ultimately your business and whether you want to take an investment or not is a commercial decision; your commercial decision.
What may appear too risky to a lawyer or accountant, may still be worth pursuing provided you understand the risks. On the other-hand what may appear to be a dream offer could come with too many strings for you commercially.
We work withmanycompanies andinvestors which has given us an invaluableinsight, notjust from a legal perspective butfroma practical and operational one.
What we have found is vital is getting your company right from the start; getting your house in order and having the best possible tax and legal advice. You get only one opportunity to impress an investor over and above your competition.
Karen Holden is an award-winning solicitor and founder of?A City Law Firm