Completing a fundraising round marks a significant milestone for any growing business. It’s essential to ensure your company is legally prepared before engaging with potential investors. Preparing your company for investment not only enhances your business’s appeal to investors but also helps in securing better investment terms. This article highlights the key legal areas to address prior to seeking investment
Share capital ownership and valuation
Ensure your share capital and ownership structure are clear and properly documented. Investors need a complete and accurate understanding of who owns shares in your company.
If you have promised shares to employees or service providers, who have agreed to take shares instead of cash payment, make sure the terms of their options or equity stakes are clearly agreed upon and documented.
Prepare a capitalisation (cap) table that includes all issued shares, options and other share allocations. This table represents the company’s pre-investment fully-diluted capital, and will be used to calculate the investor’s ownership stake.You should have your own view of what is the company’s value prior to taking into account the amount of the investment – the pre-investment valuation. This will enable you to gauge how much of your company will be available to an investor and also by how much existing shareholders’ stakes will be diluted. It also aids in securing buy-in from current shareholders on the proposed investment terms and allows you to appreciate the impact of potential counter-proposals during negotiations
A Dragon’s Den-like example
For instance, if you’ve watched shows like Dragons’ Den, you might see company owners asking for an investment of £50,000 in exchange for a 20% stake in the business. This suggests a pre-investment valuation of £200,000 – with the addition of the £50,000 investment, the company is worth £250,000, the investment of £50,000 = 20% of £250,000
If an investor counters with an offer of £50,000 for a 25% stake, they are valuing your company at £150,000
Knowing the fully-diluted share capital and the pre-investment valuation enables you to calculate how many shares the investor should receive
In a situation where the fully-diluted share capital consists of 100 shares, an investment for a 20% ownership stake would result in the investor receiving 25 new shares (25 = 20% of a total of 125 shares).
If the investment is for a 25% stake, the investor would receive 33.33 new shares. This is not a whole number of shares and rounding this number up or down to the nearest share would result in the investor’s stake (24.81%) not being close enough to 25%. You may need to sub-divide the company’s shares first – for example into 10,000 shares – so the investor receives 3,334 new shares, representing a 25.004% stake
Financial preparations
Investors will focus on two key areas:
- the company’s future financial prospects and their likely level of investment return
- the company’s past financial performance and current situation
To address the future, you should prepare a robust and credible financial forecast, including a profit and loss statement and cashflow forecast for the next few years. Be ready to explain and justify the assumptions and bases behind these projections.
For past performance, ensure that your company’s accounting records are uptodate and your accounting systems and procedures are fit for purpose. Investors will expect to see current management accounts for the ongoing financial period as well as statutory accounts for any completed periods
Asset ownership
Ensure that your company owns all its key assets, particularly intellectual property (IP). During the due diligence process, investors will verify that these are properly owned by the company and not by anyone else.
Businesses often start informally and assets may not always be held by the company. For instance, domain names may be registered in a founder’s name, a friend may have designed the logo as a favour or a web-developer has coded and hosts the company’s website.
If any intellectual property was created before the company’s incorporation or outside of an employment relationship, you may need a deed of assignment to transfer ownership to the company
Contract management
Make sure all business contracts are formalised in writing, including agreements with key suppliers and customers. Investors will want to see that these relationships are secured and documented.
Your company should also have formal contracts with employees and consultants, including clauses relating to post-termination restrictions, IP ownership and confidentiality. Founders should have service contracts, committing the founder to work full-time in the business
Legal compliance
Your company should be legally compliant. This includes maintaining uptodate company records, filings with Companies House and fulfilling tax obligations. Investors will be wary of companies with overdue or missing tax filings or those behind on VAT, PAYE or corporation tax payments.
If there are any potential disputes or loose ends, such as an unresolved issue with a former business partner, the pre-investment period is the time to address them. Investors do not want to inherit legal problems or have their investment used to resolve past disputes
Preparing for due diligence
The investment transaction will involve the investor and their advisers conducting due diligence on your company, including legal, financial and tax due diligence. Prepare for this by anticipating the information which investors will typically ask for. Gather relevant information and documents in a central location, organised by subject area, where it will be readily available when needed.
By addressing these areas, you will be in a better position to attract and negotiate investment terms and handle the investment transaction process
PaperRock Documents
PaperRock Docs provides high quality legal document templates, designed for businesses, legal and other professionals. Each document is available to purchase as a single download and is accompanied by comprehensive explanatory guidance note. Our Investing in a Company section contains documents covering the entire investment process, including legal due diligence checklists for a start-up company or for a more established business
