Venture Capital
Venture Capital
Start-ups and established businesses alike require new capital to grow. These capital infusions will probably come in multiple tranches and bring with them both strategic decisions for founders and real liability with respect to selling equity to investors. Penwell Law is ready to help you raise money while navigating the requirements of federal and state securities laws.
Finding Venture Capital
Venture capital is one option among many (including private placements and debt financing). Venture capital groups are well-funded and typically invest in start-up companies with high-growth opportunities. Venture capitalists provide infusions of cash that nascent businesses need to expand their operations or branch into new lines of goods or services. If all goes well, these growing businesses experience a surge in profitability, which they then share with their new venture capital investors.
In addition to profit sharing on a pro rata basis, venture capital groups often charge management fees for their role in advising start-ups. The “2 and 20” fee structure is common and means the venture capital group will charge the company 2% of its assets under management and 20% of the company’s profits. (Source)
Cue sticker shock…However, if a company has been turned down by banks for traditional loans and failed to raise money privately from accredited investors, venture capital may mean the difference between folding and continuing.
In addition to fees, venture capital groups tend to secure decision-making and voting rights over the company. Post-closing, the founders will typically need to obtain the vote of at least one preferred director, appointed by the venture capital group, before making distributions, passing an annual budget or business plan, entering into contracts over a certain dollar threshold or changing directions with a product or service. For founders who are used to making quick decisions with little input from others, this represents an entirely new way of doing business.
Ultimately, venture capitalists provide incredible opportunities to emerging businesses, both in terms of funding, guidance and vision. Newly-funded companies become plugged into the venture capital group’s network of partners and experts. They also have the backing of the venture capital group during subsequent rounds of fundraising. (Source)
Key Deal Terms: What You Should Know
The critical point for founders soliciting venture capital funding is to understand what they’re receiving and what they’re potentially giving up. At Penwell Law, we represent both venture capitalists and growing businesses. Like many in the venture capital space, we use the model legal documents provided by the National Venture Capital Association (the “NVCA”). The NVCA is a nonprofit association, which supports venture capital investors, businesses and industry partners. Their model documents provide the bones of a typical deal and include the following:
Model Term Sheet: Allows the parties to agree in advance upon the high-level terms of the transaction, including the price per share, fees, voting, dividend, share conversion and liquidation rights that will accrue to the investing venture capital group, as well as rights of first refusal, co-sale and drag-along rights.
Model Term Sheet: Allows the parties to agree in advance upon the high-level terms of the transaction, including the price per share, fees, voting, dividend, share conversion and liquidation
rights that will accrue to the investing venture capital group, as well as rights of first refusal, co-sale and drag-along rights.
Stock Purchase Agreement: Memorializes the negotiation points from the Term Sheet at a much more detailed level, especially in regard to the specifics of financing, and dovetails with the other model documents so that deal points remain consistent throughout.
Investors’ Rights Agreement: Sets forth the post-closing rights of the venture capital group and original shareholders to information post-closing (such as financial statements and access to the Board and company officers), as well as the parties’ respective rights to demand the company go public or to purchase newly-issued shares in future funding rounds.
Voting Agreement: Ensures the parties vote their shares as agreed in regard to the election of directors, any future public offering, the issuance of additional shares needed to effectuate stock conversions and drag-along provisions as to future sale events.
Right of First Refusal and Co-Sale Agreement: Equips the venture capital group (and sometimes the founding shareholders) with a right of first refusal to purchase certain shares prior to their sale to a third party. Given the extensive rights of certain shareholders to control the company, it is imperative that the parties understand and negotiate stock sales in advance (as the purchaser will potentially inherit those controlling rights.)
Indemnification Agreement: Typically, the investing venture capital group will want to secure indemnification rights for its appointed preferred director(s). Founding shareholders who will also serve as directors should consider whether they want the same indemnification rights for themselves.
Management Rights Letter: As previously mentioned, most venture capital groups will demand not only profit-sharing but also managerial fees. While short, this document should not be overlooked, as it contains critical provisions, including information and inspection rights that may be different or additional to those in the Investor Rights’ Agreement.
Certificate of Incorporation: The company’s Certificate of Incorporation will need to be amended at closing to enumerate the rights of the venture capital group’s shareholder and preferred director(s). The rights of each series of stock, including dividend, conversion and liquidation preferences, will be captured through this amendment.
Whether you are a venture capital group seeking outside counsel or a growing company exploring funding options, Penwell Law is here to help. We will walk you through every stage, from the term sheet to funding, closing and securities compliance.
Contact the Penwell Law Team!
We’re here to walk you through all the options for buying, selling or growing a business. No transaction is too big or too small. We routinely handle transactions in excess of $10 million, but we’ve also assisted clients with $5,000 acquisitions. For us, it’s not about the deal size. It’s about helping our clients achieve their goals. Contact us today for a no-cost consultation. You can also book a no-cost consultation directly with any member of our team here:
