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What is a term sheet and why is it important?
In this time of global crisis, your funding plans may have had to change drastically. They may have been accelerated, been put on hold or morphed into a smaller but faster bridging round. As a founder of a startup, you may be torn in many different directions (even more than usual!) and also have questions about whether you can terminate a supplier contract, or vary your own T&Cs with customers, or questions on employment and furloughing staff (or indeed yourself).
Our team of startup lawyers specialise in startup business investments and investments in early stage companies. We are pragmatic, will take action quickly and we are well used to solving (and not creating) problems. As well as advising on funding, we can also help during these uncertain times to coordinate responses to these wider pressing questions on commercials or employment.
Our approach to startup investment
We understand that you will need flexible and practical advice and so we don’t sell expensive startup "packs" that get you nowhere, we won’t over complicate legal documents and we won't baffle you with jargon. Instead, we will work with you to complete each investment and wherever possible will charge you a fixed price so you know exactly where you stand.
You will be given our commercial view on the proposed investment terms and we will do all we can to ensure that your needs are considered and your position is protected. We will then work with you to take your business or investment to the next stage.
Free consultation with a startup lawyer
Firstly, click on the button below to answer some short questions giving us some basic details of your situation and what support you require. If we think we can help you, we’ll meet you free of charge for an hour to discuss your needs in more detail.
FAQs relating to startup investments
Our recent work
- Advising Hambleden Capital LLP on its co-investment into Titan Wealth Holdings Ltd to fund its proposed acquisitions of Tavistock Wealth Ltd and Global Prime Partners Ltd (June 2021)
- Advising a family investment company on its £3.5m co-investment into a new wealth and asset management group to fund its various acquisitions (June 2021)
- Advising the founder of a mental health tech startup on his exit from the company and, in particular, the sale of his shares to the existing VC investors (April 2021)
- Advising a tech startup on a £1m follow-on fundraise from angel investors (April 2021)
- Advising a retail investor on a £7.5m investment into a wearable technology business (March 2021)
- Advising an AI startup on the exit of 2 shareholders and a follow-on raise via convertible loan notes (February 2021)
- Advising an online marketplace on a bridging round (February 2021)
- Advising a tech startup on a follow-on equity round (February 2021)
- Advising a vegan foods startup on an £800k follow-on investment from a VC (January 2021)
- Advising a venture capital company on a £1m investment into a deep-tech startup (January 2021)
- Advising a venture capital company on an investment into a software startup (January 2021)
- Advising a startup in the wellbeing space on a strategic partnership (December 2020)
- Advising an e-commerce startup on its equity seed round (November 2020)
- Advising an angel investor on a convertible loan investment into a immunotherapy and vaccine high-growth company (October 2020)
What is the purpose of a termsheet, and what should it include?
A termsheet sets out the legal and commercial terms of a transaction, such as the key terms of a share sale, an investment or a loan.
Termsheets are not normally legally binding, other than in respect of confidentiality, exclusivity (if applicable) and jurisdiction. A termsheet in respect of an investment into a startup should include details of the company, the current shareholders and the current directors; the valuation of the company and the amount the company hopes to raise; the information rights the investors will have post investment; whether investors will have ‘reserved rights’ in respect of certain major decisions of the company; details of what the funds will be used for; whether investors will have a first right of refusal on the issue of new shares or the transfer of existing shares; whether the new articles of the company will include drag or tag along rights, etc.
Termsheets are useful because they focus the mind, encourage the negotiation of key commercial terms and make evident whether there is an agreement in principle or not. They are also used by lawyers as the basis for drafting the more involved legal agreements that will need to be entered into to complete the transaction in question.
See more about termsheets in our blog 'What is a termsheet and why is it important?'
What is the legal process to be followed before completing an investment?
Before making an investment into a startup, an investor should carry out commercial, financial and legal due diligence on the startup. ‘Due diligence’ is just an investigation of the assets and records of the startup to try and establish whether these support the value the startup has placed on its shares. From a legal perspective, an investor should seek to answer questions like: has the startup raised funds before? If so, on what terms? Does the company have any debt? Has the startup issued options or convertible loan notes? Does the startup own the tech it has developed? An investor should also seek to understand the market the startup operates in, its competitors, its target customer base and its finances and forecasts.
Due diligence can be carried out individually or in a syndicate of angel investors, in which investors share their respective findings. Investors should also meet with the founders of the startup, as the team is key in an early stage investment. Can the founding team deliver their vision? Are they qualified to do so? Are they willing to answer questions that have arisen as a result of the due diligence?
Once an investor has decided to proceed in principle with an investment, we would expect him to be sent a termsheet setting out the key terms of the investment. This then needs to be discussed, negotiated and agreed.
Lawyers will then draft an investment agreement and new articles of association based on the agreed termsheet. These are the legally binding documents under which an investor makes an investment into a startup.
What are the different investment options available?
There are different options in terms of how money is invested in a startup. These include:
- Subscription for shares (otherwise known as “share capital” or “equity”)
- Convertible loan note
- Advance subscription agreement
Subscription for shares
A subscription for shares involves cash being injected into the startup in exchange for the immediate issue of shares in the company to the investor. The percentage of the shareholding/equity an investor will have on completion of the investment will be determined by a valuation of the startup at the relevant time.
Convertible loan note
On entry into a convertible loan note, monies are lent to the company in the usual way. However, on maturity of the loan, there will be the option to convert the outstanding balance into equity in the startup, instead of the loan being repaid. On a conversion such shares will often be issued at a discounted subscription price to take account of the fact the holder of the convertible loan note took a bigger risk by investing in the very early stages.
Further information on convertible loan notes can be found in our blog 'Convertible loan notes - top tips for founders of startups.'
Advance subscription agreement
One of the issues investors face when investing via a convertible loan note is that they cannot take advantage of SEIS or EIS relief (which may be available to an investor subscribing for shares). The use of an advance subscription agreement addresses this issue but still has the advantage for the startup of receiving a quick injection of cash.
If structured correctly, an advance subscription agreement enables the investor to subscribe for shares and pay for them at the date of the agreement but with the funds converting to shares at a discounted subscription price upon a future event (e.g. the next investment round).
Investors should be aware that usually, once the advance subscription agreement has been entered into, they have no right to demand their money back and the investment will automatically convert to share capital at some point. If another equity raise or exit does not occur then the investment will convert into share capital on a specified date or on insolvency of the company.
Further information can be found in our blog 'What is an Advanced Subscription Agreement?'.
As a company looking for investment, what practical steps can we take now to make us more attractive to an investor?
Get your house in order before going to investors. Put together a pitch deck and a cap table. Think about your valuation and be prepared to justify it to investors. Try and benchmark your company against other companies of a similar size or in a similar market. Practice your elevator speech, what is your USP? What do you need the funds for? Why are you the best person/team/company to deliver your service or product?
From a legal perspective, ensure that the company owns the IP in any product you are offering – are your developers consultants? If so, do their contracts contain clauses assigning any IP to the company? Do all your employees have employment contracts?
Organisation is key. Investors will want to conduct due diligence on you and the company before they invest. Put all the key documents they are likely to want to see (e.g: employment contracts of key staff, contracts with customers, loan agreements to which the company is a party, details of patent or trademark applications, your financials for the last three years (or for as long as the company has been operating if less), your CV and the CVs of your key staff…) in one place, and in order. This will make these easier to share when the time comes, make the due diligence and investment process smoother and make you look like a professional outfit.
What protections should I be looking for as a founder?
You have started a company and put your blood, sweat and tears into it, you now want to ensure you are protected post investment. As a founder, you want to ensure that the investment documentation ensures that you can always appoint yourself or someone you have nominated as a director of the company (so that you cannot be removed from the board and excluded from key decisions), that your restrictive covenants are a reasonable length, that your shares in the company are not tied to your employment with the company, that no ‘bad leaver’ provisions apply to you as a founder and that you can drag minority shareholders if you want to sell your shares in the company (if you remain the majority shareholder post investment).
This is not an exhaustive list, nor are the above protections always available/negotiable.
See more about protection for founders in our blog 'Protection for startup founders post-investment: what should you be asking for?'
What protections should I be looking for as an angel investor?
As an angel investor you should ensure that your information rights are set out in detail in the investment documentation. What information do you need to see to effectively monitor your investment? How often do you need to see it? Who will send this to you?
You should also ensure that you have a first right of refusal or ‘pre-emption right’ on any future issue of shares. This will give you the option of following on in additional fundraises and prevent you from being diluted. You also want to ensure that you are being issued with voting shares and, if the company has more than one class of share, that you understand what rights are attached to each. Does anyone rank before you?
You should also ensure that the founders are prevented from competing with the business of the company and from soliciting clients and key employees of the company, while they are employed and for a period thereafter.
Again, this is not an exhaustive list but is a good starting point.
What is a cap table, why is it important and where can I find one?
A cap table is a record of all the shareholders of a company and their respective shareholdings. It shows ownership, who has control at shareholder level, who is incentivised and who will get what on an exit.
Cap tables should include the name of the shareholders, the number of shares held by each shareholder, the percentage shareholding owned by each shareholder and a fully diluted share capital column showing what the shareholdings will look like post investment (if raising funds). Template cap tables can be found by doing a simple google search.
Make sure that a cap table includes option holders, even if these options have not yet been exercised (i.e. have not converted into shares in the startup).
Partner and Head of Department
We are proud to sponsor, and to act as legal advisers to, Angel Academe, the award-winning network of angel investors whose members are mainly women, and which invests in UK tech businesses led by women.
"...James and his team have provided invaluable support, advising both the angels in the group and the startups we're investing in on investments and other commercial matters. Their support is tailored to clients' needs and they are very transparent and fair about how they work and what it will cost."
Sarah Turner, Angel Academe
"...I have worked with Kingsley Napley LLP for a number of years, most recently with Roberta Draper and David Davies... I have found the whole team at Kingsley Napley a pleasure to deal with - They provide pragmatic, commercial advice and I wouldn’t hesitate to recommend them to my clients."
A Client, 2021