Love money, business angels, crowdfunding or Venture Capital: today, there are several means for start-ups to raise funds, each one with its own specificities. What interests us today is highlighting points to keep in mind when you are negotiating with a VC fund.
You have identified why you wish to raise funds, how much you need, according to what timing, from what type of investor, prepared your pitch deck, worked the roadshows and, oh joy, sparked the interest of several investors. From this time, the negotiations will begin particularly on the amount of the investment, the (fully) diluted pre-money valuation based on which the investor will become a shareholder, as well as the various clauses to include in the shareholder agreement.
The role of a lawyer now takes on its full meaning, not only with respect to the drafting but also regarding supporting the parties. As professional investors in a very competitive environment, VC funds require a short timeframe between signature of the term sheet and of the shareholder agreement. The negotiations must thus be fluid and rapid, in the interest of all parties. One should thus know on which clauses to focus one’s attention, identifying those which are standard business practice at the risk of losing credibility and avoiding those that could cause a loss in value or over-dilute the interests of the parties, employee participation clauses, for example.
It is important for investors to secure the shareholding of the founding members, with lock-up or exclusivity clauses, for example. Good and bad leaver clauses are also classic and are in almost all shareholder agreements. Almost all, because, as with all contracts, shareholder agreements must be adapted to each situation, especially depending on the amount of the investment or the business sector: one would not require the same type of guarantees each time. It is important to organize it in such a way that the project being developed does not terminate if one of the founding members leaves, by reserving the option to buy back his units at specific price conditions determined from the start. Neither should this issue be neglected in the agreements between the founding members if they wish to be able to attract investors later on: no one will want to invest if one of the previous founding members does not work on the project but retains a significant portion of the share capital.
We often distinguish VC funds from other types of investors because from the start they negotiate their entry and exit conditions. Particular attention must be paid to buy-back clauses, the goal of which is to protect oneself from a drop in the value of the shares in the following rounds and which may be viewed negatively by future investors and affect the founding members’ motivation. Nonetheless, we note a decrease in emphasis on the issue in favor of more balanced clauses (weight average), probably due to the influx of liquidity we have seen in recent years. Furthermore, VC funds have investment policies, and we increasingly see ESG clauses in shareholder agreements which have obligations for the company to attain certain objectives.
A lawyer’s added value is not limited to holding a pen in this situation but also to defuse and resolve several problems that could arise during due diligence or closing and that could put a stop to the smooth progress of the deal. We see it regularly; entrepreneurs have a project and do everything possible to make it happen. The result: the legal, regulatory or simply good governance aspects are sometimes completely neglected – not willfully, but due to a lack of time or qualified support.
With a high volume of fundraising transactions, whether at the early stages or in the development phase, DSM Avocats à la Cour is part of the Luxembourg landscape to accompany you in your transactions. The best advice to give entrepreneurs wishing to attract VC funds? Continue to address your future clients and do not just think of investors, VC funds seek start-ups with a high development potential, show them what you are capable of!