Considerations before accepting investors in your company

A private equity investor may become involved in a company at any stage of the company’s life.

It might be in the early stages to raise capital to fund the company or once a company has been in existence for many years, to help sustain a period of planned growth.

If you are looking to introduce an investor into your business this will usually have some effect on the balance of power within the company since most investors will, in exchange for their investment, seek to gain some form of equity return.

For example, in return for their investment, there may be an allotment of shares, or a transfer of shares from existing shareholders, to the investor, which carry voting rights (diluting the existing voting power of the current shareholders of the company) and/or rights to a dividend.

Tom Haywood, Associate in the Company Commercial team at Wake Smith, looks at the importance of carefully considering private equity investment into your business.

This article covers:

• Matters to consider before entering into discussions with a potential investor
• What rights may the investor want?
• How will the investor exit?
• How to document the investment
• Your next move, and how we can help

 

Matters to consider before entering into discussions with a potential investor

Before entering into any discussions with a potential investor about your business it is a good idea to enter into a confidentiality agreement, also known as a non-disclosure agreement, with the investor to protect any commercially sensitive information disclosed to the potential investor, and vice versa (as is the case with any type of corporate transaction).

What rights may the investor want?

An investor is likely to offer an investment into your business with expectations of what they will receive in return for it.

On many occasions, an investor will want to receive shares in your company in return for their investment.

It is common for an investor to ask for the right, and in many cases, be granted the right, to:

• Appoint a director of the investor’s choice to represent the investor at board meetings (with the ability to remove that director, and appoint a subsequent director of the investor’s choice). This could result in the founding directors of the company being outvoted on matters in relation to management of the business.
• Appoint an observer to attend all board meetings – it is likely that the observer will require a specified number of days’ notice prior to the board meeting take place, and to be provided with all documents to be discussed at the board meeting (for example, management accounts, agreements to be entered into etc) and
• The right to veto “Reserved Matters”. This is typically phrased as a list of actions that the company cannot undertake unless the investor’s consent is obtained, often in writing. The list of “Reserved Matters” can be wide-ranging, and might include matters such as entering into commercial contracts in excess of a specified amount, transfers of shares, issuing additional shares, amending banking facilities, varying the terms of employment contracts, and many more matters.

Each of the above will impact the day-to-day operation of the board of the directors and the company as a whole, including matters put to the shareholders of the company.

 

How will the investor exit?

Although it is an exciting time welcoming an investor into the company, it is important to consider how the investor will exit the Company from the outset of the relationship.

For example, can the investor (if it is a company) transfer their shares to other members of the investor’s group? If the investor decides to exit the Company, will the Company have first refusal on buying the investor’s shares, or some other arrangement? Will the company and/or its shareholders have the right to buy the investor’s shares once a certain level of profit has been generated?

It is also important to have an exit strategy in case the relationship with the investor breaks down (for example, if there is a deadlock situation where the parties cannot agree how to proceed).

To protect all parties involved in the investment, it is sensible to document the terms of an investor’s exit in the investment agreement (see further details below).

How to document the relationship with an investor
To ensure that all of rights, restrictions and protections are properly dealt with, and recorded, it is important that the terms are properly documented and this would usually include the following documents:

• Confidentiality Agreement/NDA – To protect confidential information being disclosed.
• Investment Agreement - This is the main document that will set out the key terms of the investment by the investor and will cover a diverse range of matters such as (this is not an exhaustive list): the terms of the investment; the investors rights following investment; the investor’s exit; and how the company will be managed.
• Articles of Association – Articles of Association are the constitutional document for the Company. It is likely that an investor will require certain amendments to be made to the company’s articles of association, to reflect certain rights of the investor (such as, a transfer of shares), to protect the investor’s position in a public document at Companies House.
• Shareholders’ Agreement – It is possible for all the obligations between the investor and the shareholders to be included in the Investment Agreement, however, to future proof the future relationship with the investor and any additional shareholders joining the company, the parties may also want to enter into a separate shareholders’ agreement. The shareholders’ agreement is also the best place to document any commercially sensitive arrangements between the investor and the shareholders of the company.

Your next move, and how we can help

If you are thinking about accepting a private equity investment from an investor, it is vital to carefully consider how the company will operate in the future and what protections might be reasonable for you and/or the new investor at both board and shareholder level.

Wake Smith Solicitors is experienced in advising businesses receiving investment from investors.

If you would like to discuss this further, please contact our reception on 0114 226 6660 and ask to speak to a member of the Company Commercial team.

Find out more about our Company Commercial law services

Re-published 10/10/2024