Here is a short story about Adeolu:
Adeolu founded AtechNG, a technology startup, in 2021. He was able to call in personal favours and get loans to float his company in addition to his savings. After one year of operations, it is now clear that AtechNG’s growth potential is huge, and the future looks bright for the company. There is, however, one little (well, not so little) bump in the road: Adeolu does not have the finances to keep funding AtechNG. Yikes! Adeolu understands that it is time for him to begin searching for external funds. He drafts a pitch deck, and after a few months of presenting to several investors and venture capitalists (VCs), he finally finds a VC willing to invest in AtechNG. Adeolu is so excited about the news that he calls up his lawyer friend, Titi, and shares his breakthrough with her. Titi tells him to look before he leaps, as there are essential legal considerations and documentation involved in securing startup funding.
Just like Adeolu, many startup founders are in search of funding for their businesses, but as Titi said, “look before you leap.” After sending your pitch deck to your investor(s), if they show interest in your startup, they will want to check the appropriate legal boxes before investing. Let us look at a quick summary of the legal procedures and documentation that go into equity funding for startups:
- Due Diligence: Before investing money in your business, potential investors will conduct research on your startup to ensure that they are not inheriting any problems.These inquiries may be to see if there is any existing litigation against your startup, that you have no tax liabilities, and that your financial records are a true reflection of the state of the company. They may also want to peruse existing contracts and agreements to ensure that you are in regulatory compliance or that the company owns the intellectual property. So get ready to oblige them with documents to aid them in their due diligence.
- Termsheet: A termsheet is a document outlining the terms under which an investor is willing to invest money in a startup. This document covers certain details such as company valuations, investment amounts, the percentage of stakes, voting rights, etc. A termsheet is, however, not in itself a binding agreement; it is merely an offer by the issuing party, which can be reviewed based on what is ultimately decided between the two parties (i.e., the investor and the startup). A signed termsheet typically reflects the subsequent definitive agreements that will be entered into by parties.
- Amended Articles of Association: If your startup is already registered, one of the documents you will have to amend or restate after receiving investment is the Articles of Association. Ordinarily, the articles of association contain the governing powers of the company, as signed by all shareholders at its incorporation. Since shares in the startup will now be issued to investors, the articles have to be amended to include the new investors and reflect the new governing terms and powers of the company.
- Definitive agreements: The definitive agreements are binding contracts reached based on what is included in the final termsheet and they reflect what is contained in it. These preferences include, but are not limited to:
- Stock Purchase Agreements (SPA): This document finalises all terms and conditions related to the purchase and sale of a company’s shares.
- Share subscription and Shareholder Agreement (SHA): this document sets out the rights of each shareholder by outlining the details of their ownership. It also contains how the company is to be operated and the constitution of the board, including the appointment of an investor on the company’s board where applicable.
There are a number of other documents that are required during a fundraise, and it is advisable for founders to take all the necessary steps when receiving external funds to ensure that the necessary documents are drafted and signed, so the consequences of not having them are avoided.