Raising funds for your startup is a pivotal step toward growth, but it also comes with a significant amount of legal paperwork. Navigating the legal requirements can feel daunting, especially for first-time founders, yet understanding and preparing these documents is essential. Proper legal documentation not only protects your interests but also builds trust with investors and ensures that everyone is on the same page regarding the terms of the investment.
1. Pitch Deck and Business Plan
Although not legal documents, a pitch deck and business plan are crucial in attracting investors and laying out your vision. These documents should provide an overview of your product or service, business model, market analysis, and financial projections. A clear, compelling pitch deck and business plan make it easier for investors to understand your potential and engage in deeper discussions about the terms of the investment.
2. Non-Disclosure Agreement (NDA)
Before you dive into detailed discussions, you may want investors to sign a Non-Disclosure Agreement (NDA). NDAs protect sensitive information about your business, including proprietary technology, financials, and strategic plans. While many experienced investors may be reluctant to sign NDAs—often citing a large volume of investment opportunities—it’s worth discussing if your business has unique trade secrets or intellectual property you want to protect.
3. Term Sheet
A term sheet is a preliminary agreement that outlines the key terms and conditions of an investment. It’s not legally binding but sets the foundation for more formal documents. Term sheets typically cover aspects like:
- Valuation: The company’s worth, which helps determine the investor’s ownership percentage.
- Investment Amount: How much the investor is committing.
- Equity Type: Common or preferred stock, or other investment vehicles.
- Investor Rights: Voting rights, board representation, or other governance aspects.
- Exit Rights: Details on what happens if the company is sold or goes public.
A well-drafted term sheet helps to prevent misunderstandings by clearly outlining the expectations and requirements of both parties.
4. Subscription Agreement
The subscription agreement is the formal contract in which the investor agrees to purchase shares in the company under the terms outlined in the term sheet. This legally binding document finalizes the investment details, including the number of shares being issued, the price per share, and the payment terms.
Subscription agreements may also include “representations and warranties,” where both the founder and the investor make certain statements about their legal ability to enter into the investment, and any misrepresentations could lead to legal consequences.
5. Shareholders’ Agreement
The shareholders’ agreement is a critical document that governs the rights and responsibilities of all shareholders, not just the new investor. This agreement typically covers:
- Board Composition: Who will serve on the board, and how voting will work.
- Voting Rights: Which matters require shareholder approval.
- Share Transfer: Restrictions on selling shares to ensure ownership remains within agreed parameters.
- Pre-emption Rights: Allowing existing shareholders the first opportunity to buy new shares issued in future funding rounds.
- Exit Clauses: Outlining processes for an acquisition, IPO, or other exit strategy.
The shareholders’ agreement helps prevent conflicts among shareholders by establishing clear guidelines for decision-making and equity transfers.
6. Investor Rights Agreement
The investor rights agreement is specifically designed to address the rights and protections of investors. It often includes:
- Information Rights: Allowing investors access to key financial documents and business updates.
- Registration Rights: Ensuring investors can sell their shares if the company goes public.
- Right of First Refusal: Giving existing investors the option to purchase any shares the founder might sell.
- Anti-Dilution Protection: Safeguarding investors’ ownership percentage in future funding rounds.
This agreement builds investor confidence by ensuring transparency and protecting their interests.
7. Capitalization Table (Cap Table)
A cap table is a spreadsheet or ledger that tracks the ownership of shares in the company. It includes details of all shareholders, including founders, employees with stock options, and investors. The cap table helps investors understand the equity structure and any dilution risks.
Keeping an up-to-date and accurate cap table is essential, as it allows you and your investors to see how ownership will be impacted in future funding rounds or if employees exercise stock options.
8. Convertible Note or SAFE Agreement
If you’re raising a bridge round or initial seed funding, you may choose to issue a convertible note or SAFE (Simple Agreement for Future Equity) rather than selling equity immediately. These agreements allow you to take in investment now, with the investment converting into equity at a later date, typically during a future funding round.
- Convertible Note: This is a short-term loan that converts to equity in a future round, often with interest.
- SAFE: A more straightforward document where the investor provides funds in exchange for future equity.
Both instruments allow you to raise funds without immediately determining the company’s valuation, which is often difficult in early stages.
9. Employment and IP Assignment Agreements
Investors will want to ensure that the company fully owns all intellectual property related to its products and services. Employment and IP assignment agreements with all team members are essential for securing rights to any technology or intellectual property developed. These agreements clarify that any innovations, code, or ideas created by employees are legally owned by the company.
10. Disclosure Schedule
A disclosure schedule is often attached to investment agreements and lists any exceptions to the representations and warranties made by the company. For instance, if there are existing liabilities or pending legal disputes, these would be disclosed here. This document provides transparency, giving investors a clear view of the company’s current situation and protecting the founders from claims of misrepresentation.
Conclusion
Preparing for a funding round involves more than just pitching to investors; it requires a robust set of legal documents that define the terms of the investment and protect the interests of both founders and investors. Working with a knowledgeable legal advisor can help ensure that your documents are in order and that you’re aware of the implications of each agreement. By understanding and securing the necessary legal documentation, founders can focus on their primary goal: driving growth and building a successful business.
