Investment Agreement: proper structuring of relations

Competently executed relationships between the investor and the project team will help avoid possible misunderstandings in the implementation of further tasks on products, delimiting and securing the scope of activities (a software company investor agreement).

with an investor to protect your rights when investing, and those of the team members, especially if you decide to continue or end your relationship with an investor.

Many investors, however, enter into an investment contract in IT, investing in IT projects, ranging from applications for smartphones to the development of nanotechnology, with the expectation that the project will yield profits or dividends some day.

At the same time, investors should protect themselves as much as possible, protect their interests when investing in a startup, while structuring a deal and agreeing to contracts (startup investor agreement). There are many ways to raise funds and, “investment contracts” alike.

A loan is a classic tool to raise funds.

The company finds an entity or a person who agrees on certain conditions (term and interest) and for certain security to provide a certain amount of money for the use of the company.

To avoid such a situation and in order to protect the rights and interests of the investor, you can structure the deal in the form of a convertible loan. In this case, the actual value of the company will be determined by the market – that is, by the investor of the next round of funds raising (for example, during the IPO, initial public offering). In most cases, the result of the assessment suits both parties. In order to compensate the risks of an early investor and to create certain advantages for investors in subsequent stages, various mechanisms are used to structure transactions along the path of convertible loans, the most important of which are Maturity Date, Discount and Valuation Cap.

M Maturity Date is a condition that sets the period by which the next round of raising funds should come. If a new round of investment does not occur, then, according to the terms of the contract, the condition "Conversion on Maturity" is triggered. Conversion on Maturity usually takes one of three forms: the postponement of the next round of investment or the repayment of a loan with interest, or the forced conversion into shares under the terms of the Maturity Cap - for example, a company sells 50% of its shares to its investor. If the next round of investment takes place, then, according to the terms of the contract, the debt can be repaid provided that such debt is converted into the securities of the company. In this case, the two remaining parameters apply - Valuation Cap and/or Discount.

The Valuation Cap regulates the highest valuation in the opinion of the investor and startup, which can be used to determine the price of converting a loan into a company's share. A convertible loan agreement that does not have a Valuation Cap is extremely dangerous and high-risk for potential investors. In this case, if there is a significant increase in the company's valuation (for example, at IPO), the investor may not receive substantial benefits from this.

Suppose that the initial investor invested $500,000 under a convertible loan agreement in a company that quickly became self-supporting and did not initialize the next round of fundraising for a long time. In such a round, the company raised funds from a new investor in the amount of $ 5 M while valuing the company at $ 20 M. Thus, the situation is that a new investor who is not exposed to the risk of losing investments, receives 25% of the shares (5,000,000 / 20,000,000 = 0.25), and the initial investor, who believed in the team at the project construction stage, receives only 2.5% (500,000 / 20,000,000 = 0.025).

To avoid this situation, there is a Valuation Cap. If the investor and the company agree on a Valuation Cap, for example, of $5 M, then if the company was valued at $20 M, such an investor would receive a share on the assumption that the next round would be valued at $5 M, not $20 M. Thus, the initial investor can convert his loan into 10% of the shares of the company (500,000 / 5,000,000 = 0.1), and not by 2.5%, as described above.

However, if the company's valuation is lower than that fixed in the Valuation Cap, then the investor can receive a discount at a further level of fundraising. So, if a new investor owns the company's securities at a price of $10 per unit, but a converted loan agreement is concluded between the company and the original investor with a discount of 20%, then the original investor can turn his loan into the same securities, but at the price of $80 per unit, thus obtaining more shares and exercising his rights as an early investor.

Also, when drawing up a convertible loan agreement, the following conditions must be taken into account: Qualified Financing (what is considered an investment round and what is not) and Most Favored Nation (a mechanism by which a company agrees to provide the investor with the best conditions that the company provides to any other investor - for example, within discount and valuation cap).

This document usually outlines:

• purposes of establishing a joint venture,
• initial contributions of the partners;
• a list of day-to-day (ordinary) operations that may not require the consent of the board of directors/shareholders;
• the matters for which such consent is required (how the joint venture will be controlled and managed, etc.).

It is crucial to entrust the establishment of a joint venture, including the preparation of the articles of association, shareholder agreement, joint venture agreement and other legally important documents to professionals in order to avoid future litigation.

While selecting a jurisdiction for a joint venture, several questions need to be explored, the main ones being: