Raising finance, be it seed capital, angel money or venture capital funding, requires the preparation and distribution of legal documentation containing the proper technical jargon of corporate finance law.
Private Placement Memorandum (“PPM”)
The PPM is usually used by a company after the seed and angel stage, when local VCs have invested in the company, and now it is looking for the second, third or fourth round of serious capital which is generally foreign money. The PPM allows investment bankers to meet the requirements of the securities law and raise capital quickly from institutions and accredited private individuals. Generally, the investment banker or corporate finance specialist who is helping to pull the financing together will draft the document with the help of the company and its accountant.
The first page of the PPM will state such matters as that the investment banker is the financial agent for the company, the reasons why there is a high risk in investing in the securities offered, that the private placement is being done under certain exceptions to the securities laws, and that no regulatory government agency has reviewed or “passed on the merits” of the PPM. Various disclaimers about the financials and the business follow, and the names and addresses of the company’s agents to be contacted by the investor.
Then comes a Table of Contents setting out the following main sections:
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Executive Summary, giving an overview of the company, the offering and use of the proceeds and a summary of financial data
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The Company, dealing with the business, the markets, the strategy, the products and services, product technology, facilities, employees, competition and management
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Financial Statements
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Risk Factors
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Shareholders Capitalization Table
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Subscription Procedures
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Appendix - Tax considerations.
The PPM is structured in such a way that each type of investor is told the “same story”, offered the “same deal”, and the investors have the choice of taking down “one unit” or many units. The unit is a specific minimum investment amount of say $100,000, larger when institutional investors are involved. By keeping the terms of the securities offering identical for each individual investor, the company and the investment banker know ahead of time exactly what percentage of the company they are selling in total.
As we mentioned last week, the PPM can also be used by a publicly traded company to raise private capital when the company cannot make a “secondary offering” to the public to raise funds for expansion.
The offering is closed by the investor signing on a subscription agreement which is usually attached to the PPM package of documentation, and the transfer of the investment monies.
Term Sheet (“TS”)
Depending on where the company is at in the life, the TS and Share Purchase Agreement (“SPA”) are sometimes better documents to begin with for seed and angel money, rather than a PPM. The TS and SPA allow a strategy of “divide and conquer”, and making the deals somewhat individually oriented. The investor will still receive a business plan or pieces of the PPM, but the company is willing to incur the risk of presenting a “customized package” to the investor, as opposed to the uniform PPM package.
The TS is like a Letter of Intent between the parties. The TS locks both parties into a deal for a certain period of time. It prevents the company from “shopping the deal” to other potential investors. The TS nails down terms between the parties so they can go smoothly to the next stage of drafting the final and binding SPA. It gives the investor some time to do due diligence of the technology, finances and legalities of the company. The TS process results in the company quickly understanding its preliminary worth to any potential investor, without having to sign a formal binding agreement.
The negotiating process around the TS is a great exercise for a company in getting itself organized in a professional manner. Company papers are organized to meet due diligence demands of the investor’s counsel. During this process the company discovers how talented or otherwise its advisors are. Sometimes this discovery results in the company dismissing its original lawyers and finding more professional counsel.
“Terms” in the “Sheet” are a very brief summary of most of the main terms of the SPA which will follow upon the signing of the TS:
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Amount of investment
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Type of security being purchased
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Shareholders capitalization table
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Company valuation
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Price per share
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Closing
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Use of proceeds
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Liquidation preferences
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Anti-dilution
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Voting rights
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Rights of first refusal
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Restrictions on founders’ sales and co-sale rights
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Bring along rights
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Employment agreements and vesting of founders shares
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Board of directors
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Signatory rights
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Due diligence period
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Representations by the parties
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ESOP
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Confidentiality
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No-shop period
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Closing conditions
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Expenses
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Non-binding TS
There of course can be many other terms and conditions in a TS depending on the negotiations between the parties. Various percentages of shareholdings are used to trigger different rights, and to truly understand how to use these terms in negotiating with an investor it is best to consult counsel and your investment banker.
Once the TS is signed with the seed, angel and/or VC fund, the parties have their “homework” to do. The company has to be ready to supply relevant due diligence written materials to the investor’s representatives, as well as have its technical and marketing people available for discussions with the investor and his representatives. This process is a delicate balance between the company giving the investor comfort and not disrupting the company’s day to day business. It takes an immense amount time away from management’s daily schedule. Therefore it is of prime importance that the company use advisors who know the ropes and can inform management what is important and what isn't.
Share Purchase Agreement ("SPA")
Once the investor is comfortable with the preliminary stages of due diligence, they will give the “green light” to a lawyer to draft the SPA, the binding legal contract between the parties. Companyies prefer the investor’s counsel to draft the SPA. This way if there is no deal, the company does not pay for investor’s counsel. If there is a deal, the custom is for the company to pay for the investor’s counsel and it’s own counsel.
The SPA takes the TS and “blows it out” into a formal binding agreement. The following are the main themes of the SPA:
- The closing of the issue and purchase of the shares. This requires completion of various transactions by the company and/or the investor and delivery of documents to the relevant parties in the transaction. Various appendices which deal with the corporate finance terms referred to above in the TS are part of the documents to be completed and delivered, such as the Articles of Association, the Shareholders Agreement, and the Investor Rights Agreement;
- Detailed representations, warranties and covenants by the company to the investor relating to the technology and the founders;
- The investor, in turn represents that it is aware of the risks involved and the regulations governing this transaction under the securities laws;
- Detailing of conditions to closing which encompasses the representations and warranties, the covenants, the consents, delivery of documents, waiver of rights, etc. This allows the parties to refuse to complete the transaction after it has been signed if these conditions have not been met;
- Various legal clauses associated with any contract, including an indemnification that allows the investor to obtain his investment back from the company as well as be protected if it is discovered that the company is being sued successfully for infringing on others' technology.
Published by Israel's Business Arena on December 6, 2000