Source: Hopes & Fears
Branan Legal Managing Partner Maxim Bunyakin told H&F what to pay attention to in relations with Investors.
Agree on Shore.
Before starting any business with a partner, be it a business angel from Silicon Valley or a summer cottage neighbor, you should conclude an investment contract. It confirms key arrangements of all project parties, such as the author, investor, and contractors. Typically, the contract describes a financing scheme, a management structure, rules of parties’ “scam”, and methods of conflict resolution.
In fact, an investment contract is only a project execution instruction, which is sure to be followed by all the parties who have signed the contract. This is not the only project document; a new company should have the so-called “legal binding”: the articles of association, a shareholders agreement, option agreements, loan contracts, pledge contracts, and license agreements.
Find an Assistant.
The first step of a businessman while executing a transaction is to involve his own lawyer. The transaction will not have a general lawyer, as each party must represent its own interests. Although the lawyer’s service may be expensive (from $10,000), it should not be neglected for the value in dispute is too high. You should choose someone who has already worked with start-ups and has made such transactions. Even if you have found a good, reliable lawyer, you should always control the situation. You should understand clearly the terms of a transaction. And if there has been something unclear you should question the lawyer closely about it. You should start with clarification of the main subjects: distribution of shares, following rounds of financing, board of directors.
Consider All Details.
In an investment contract it is important to reflect what you have agreed upon with a partner: forms and stages of financing, key figures of a business plan, project milestones, and order of company management. All the figures must be measurable and provable. In a contract I have found a provision regarding the responsibility for violation by 50% of the project launch date – July 1, 2013. It would be very interesting for me to see how one would be able to prove in practice that the date was violated exactly by 50%. I have also seen a contract without any documentary proof of control points’ fulfillment which is acknowledged by the parties – and this is an assured cause for debate.
All legal mechanisms should be spelt out clearly in the contract. You should spell out clearly the procedures of taking decisions, order of parties’ interaction, responsibility for any violation of agreement and security for implementation thereof. I often saw contracts with a conceptual character only. Actually, they had no difference from a fiction – a story or a tale.
Foresee All Variants.
You should check every provision of the contract whether it is performable in case of a conflict (I am referring again to a symbiosis of sound logic and legal drafting methodology). Starting a project you should realize clearly how you will finish it. That’s why it is important to reflect all scenarios in the contract.
A positive scenario is a friendly parting of the partners. In this case you should specify in details the terms of receiving share options of your not yet existing company which by the moment of parting may start IPO, formulas of pricing the shares to be redeemed, due dates, payment security, and other peculiarities.
A negative scenario is a conflict situation. It is important to fix utmost clear the terms of implementing penalty options (compulsory purchase or sale of shares), dispute resolution procedures and ways to break the impasse (you can even use a lot or flip a coin – the main thing is to identify it in the contract).
Choose Right Country.
If a conflict with a partner goes too far you will have to apply to court. You may spell out in the investment contract in which court exactly a dispute will be settled. It is no secret that many large Russian companies prefer to draw up contracts under the English law. Why do they do that?
The main advantage of foreign jurisdiction is better chances of judicial defense. There is a longer-standing model of investment relations in the common law and, accordingly, the prospects of success in court are higher if the contract is violated. For example, if the partner tries to avoid sanctions for the violation of the contract, most probably, the court will take your side. In the Russian law such mechanisms are less effective yet.
But you should keep in mind that many responsibilities will have to be implemented in respect of a Russian company. In this case you cannot avoid legal and corporate procedures under the Russian law. A creative and active Russian lawyer can make a lot of problems for the party, which established its case in foreign court. Besides, concluding a contract under foreign jurisdiction costs more, as a rule, because it requires involvement of highly-paid specialists in international law. This factor often becomes critical for beginner businessmen and they conclude a contract under the Russian legislation – just with a savings view.
Choose Right Financing Structure.
As far as I can see, at the initial stage most projects are financed through the equity capital, that is, the author receives money in exchange for a share in future business. A big psychological minus of such a financing scheme for the project creator is a possibility of investors’ interference in affairs of the company. The more successful is the business, the more burdensome is such interference.
If a businessman thinks that at a present stage his company valuation rebates a lot the cost it is to have by round A, he may offer investors to effect a transaction on the terms of a convertible debt. Investments are received as a loan and when attracting the next round of financing the investor will be able to convert the loan into a share of ownership with a conversion ratio defined in advance. The main disadvantage of such a transaction is a need for security, that is, a pledge or a guarantee.
I would recommend working out at first a detailed financial model of a company with variable parameters. This model will allow calculating the result from the use of various financing forms and terms. In this case it is better to focus on negative case scenarios but not to include into a model low credit rates and explosive revenue growth during the second year of project life. Be pessimistic.
You should be aware that after a transaction the company’s decisions will be taken otherwise than now, as the board of directors will appear. I advise you to agree thereupon when drafting an investment contract. Who will, for example, take decisions connected with the budget and staff changes? If you pass these functions to the board it may slow operations in the company very much. You may involve independent experts to reduce internal tension in the board. If the investor agrees with such a term, it will indicate that he is not inclined towards authoritarian management.