VC Agreements

Overview

The primary agreement in a venture capital investment comprises a shareholder’s subscription or investment agreement, delineating the future operation of the company during the investment period. This process is similar to that applied when purchasing a private company—refer to the section on share purchase agreements.

The agreement may specify the application of the subscription fund, sometimes mandated for specific purposes as a precondition.

The investor might have an option to acquire additional shares up to a certain amount at the original or reduced subscription price. Occasionally, such options are extended to the managers of the venture capital entity as an incentive for increasing shareholder value.

Please refer to the sections on minority protection for joint ventures and shareholders for an overview. This includes vetoes over critical operational matters such as capital expenditure, director’s remuneration, dividend payments, appointment of new directors, changes in the business, and issuance of shares.

The investor agrees to acquire shares in the company and subscribe to the required capital. There might be a combination of loans, shares, options, etc., as discussed in other sections.

Documents

The common documents involved may include the following: an investment/shareholder’s agreement, tax indemnity, disclosure letter, new company constitution, business plan, and service agreements with key personnel, alongside due diligence reports.

Documents will be prepared to facilitate the completion and implementation of the investment. These typically comprise minutes and resolutions, appointments, consents, and other completion matters. The investor usually seeks protections similar to those required by a minority shareholder or joint venture partner.

Warranties and Indemnities

Investors might seek warranties and indemnities akin to those sought when purchasing an interest in a company. Warranties and indemnities are often requested from directors, promoters, and controllers. The corporate vehicle itself may offer limited value, and provisions for proportionate loss reimbursement might be established.

Directors and promoters with minimal economic investment in the company may be hesitant to provide warranties and indemnities. Consequently, limitations on individual liabilities may be necessary or agreed upon.

Liabilities and risks may be disclosed against warranties in a letter of disclosure, limiting warranties to undisclosed liabilities as part of the investor’s due diligence exercise.

The tax indemnity will not apply to transactions entered after the reference accounts in the ordinary course of business. Indemnities, particularly tax indemnities, might have conditional terms, usually agreeing to cover losses on a one-to-one basis and not typically reduced by disclosures. However, liability for taxes outside the normal course may be covered by indemnity.

The breach of warranty treatment might be specified in the agreement, reimbursing a part of the loss to the shareholder or the company. The investor could have the option to choose the reimbursement or require the warrantor to make the payment as selected.

Management

A crucial aspect of the investment often relates to the human capital of the management team. Original founders, entrepreneurs, and promoters are critical to the business’s success. Investors might require leadership arrangements and commitments from them.

Investors may aim to bind key management personnel through service agreements, incentivizing them under the share purchase agreement or granting standalone rights in separate agreements. In some venture capital scenarios, there could be a rescue or reconstruction, leading to the replacement or reduced role of the original entrepreneurs and promoters.

Management might be obligated to sign agreements, devoting most of their time to the company’s business. Restrictive covenants might be enacted to prevent them from working for, investing in, or having interests in competitor entities. There may be restrictions on disposals of their shares for a period in order to tie in and keep them committed to the company so that their interest is aligned with those of the investor.

There may be key man insurance in respect to key members of the management team. This provides compensation to the company in the event of the death or perhaps permanent disability of the key management. It may be for a lesser period before a replacement can be engaged.

Dividends

There may be commitments in relation to the payment of dividends. If the investor wants capital growth, there are likely to be prohibitions on the payment of dividends without its consent. If dividends are contemplated, there may be obligations to pay dividends where distributable incomes are available.

Dividends are also relevant to the entrepreneur/promoter’s remuneration. The investor may wish to have controls in relation to this in order to prevent the promoters from acting in their own interests by distributing funds to the detriment of the company where the funds are contemplated for company use and repayment of the investment.

Monitoring

The investor shall wish to monitor the investment. They will require regular management accounts and other financial information. They may require the appointment of a non-executive director.

In some cases, they may appoint a person who has rights to attend the board without being a director in the case of a smaller investment. The Companies Act, 2014 gives greater scope for appointee directors in terms of their corporate duties.

The director may be a benefit to the investee company, where he or she is experienced and can give guidance and introductions to the management team.

The nominated director may also liaise in terms with the investor or investor group generally in relation to an ongoing relationship. Concerns may arise for investors in relation to matters. With an investor-appointed director in situ, they are may be better able to understand the reasoning for particular proposals and justification.

Removing Non-Core Elements

The investor may require that the balance sheet of the company is tidied up so that it deals only with the business. If the promoters have placed private assets such as houses, cars, private cars, private and possession articles, etc., that are not part of the company’s running, the investor is likely to require that these be placed under an arm’s length arrangement.

They may constitute part of the implicit remuneration package. However, the investor will want to have this transparently defined and agreed so that there is no further income or benefits from the company than as defined and agreed.

Restricting Borrowing

The investors may seek to place borrowing restrictions on the company. The investment would be geared to carry a certain degree of leverage, and the investor will not wish to have this affected without its consent or above. It would require priority in terms of repayment of interest and capital over most finance.

External borrowing will typically require investors and shareholders to subordinate any debt which would otherwise automatically have preference to preference or equity shares. The promoters will wish to assess restrictions carefully in principle. They argue that if a lender is willing to lend that the investor should not, in principle, object. The investor may require rights to consent or even to lend, a matter to which the promoter may object.

Payment of Fees

The venture capital investor may seek to charge a fee for fees and expenses in connection with the initial investment, monitoring the company, legal fees, tax, and other advisory fees on an ongoing basis. They may require the professional fees in connection with the documentation to be paid by the company. They may require the non-executive directors’ fees and expenses to be paid.

It may be provided in the initial heads of terms/agreement that the obligation to pay the investor’s fees must be paid regardless of whether the investment proceeds, fees, and cost. These arrangements may breach Companies Act restrictions on assistance on the finance of shares. That would not usually be recoverable as it would not be an input of the company’s vatable business as such.

The position in respect of financial investment is arguable. It is argued that provision should be interpreted narrowly, and that the payment of fees would not constitute financial assistance in substance. However, other views are distinctly arguable. Approval Procedure may be available to whitewash the matter. This may be done as a matter of prudence even if the substantial prohibition may not be infringed.

Investigation of Problems

The investors may resolve the rights to undertake an investigation of the company’s affairs if it is not meeting requirements or expectations. They may require the right to appoint an accountant to investigate the affairs of the company at its expense. They may be entitled on certain findings on an investigation to take control of the company, including a placement of the existing management.

This may occur in defined circumstances such as depletion of capital, accumulated losses. The investors may obtain power to appoint the majority of the board; they may not necessarily exercise it.

Confidentiality

Investment agreements will usually provide confidentiality provisions regarding the company’s proprietary and other confidential information. The investor’s appointee as director would be entitled to remit information to the investor without breaching the obligation. A non-director/observer at board level may also be entitled to relay management and other information relevant to the investment.