As we noted in our blog post about startup financing options, startups can implement various strategies to stay afloat (and thriving), including: bootstrapping, crowdfunding, traditional loans, convertible financing, and equity financing. Most startups implement the following series of fundraising rounds: family and friends, Series Seed (typically convertible debt), Series A, Series B, and Series C.
First and foremost, the startup should have completed key legal items for a successful due diligence process (and future investment). These key legal items include conditions like the startup being a Delaware C-Corp entity.
Typically, Series A fundraising takes the form of Convertible Preferred Stock, providing the investor(s) with specific economic and control rights, including the right to exchange preferred stock for common stock down the line. These rights might also include liquidity preference, board seats, and veto powers. This blog post briefly discusses the most pertinent legal documents that your startup will touch during a Series A round. For a comprehensive overview of the model legal documents for a Series A, we recommend checking out the National Venture Capital Association’s resource list.
A term sheet is a mostly non-binding that lays out what the parties intend to agree to. The investor provides the term sheet at the start of the potential investment. This agreement includes provisions, like: intended purchase price, due diligence procedures, closing conditions, confidentiality rights, exclusivity, and indemnification rights. Although most of the term sheet is not binding, the exclusivity and confidentiality clauses are typically binding. The term sheet formalizes the investor’s offer and provides an extra layer of protection in case of a dispute.
Amended & Restated Certificate of Incorporation
Most Series A deals result in the investor(s) receiving preferred stock in the company. Because of this, an amended and restated certificate of incorporation is likely required. This document reflects the company’s the change in economic and control rights.
The amended certificate of incorporation requires majority shareholder approval. Most corporations should include a “blank check stock” provision in the company’s certificate of incorporation because it allows the board to create separate classes of stock (i.e. preferred stock) without shareholder approval. Thus, even though the amendments require a vote, the addition of the preferred stock class would not.
Investors will likely require that specific provisions are included in the certificate of incorporation, like: blank check stock provision, certain veto rights, and right to first offer / refusal (upon future investments). All changes should be voted on simultaneously.
Preferred Stock Investment Agreement
The Preferred Stock Investment Agreement, or Stock Purchase Agreement, is a lengthy document that is binding (once signed) on the relationship between the investor(s) and company. This document formalizes the investor and startup relationship by setting forth very specific terms related to the deal’s purchase price, representations and warranties, indemnification, and closing conditions.
Investor Suitability Questionnaire
An investor suitability questionnaire proves to the Securities and Exchange Commission that the investor is “accredited”. Among other requirements, the completion of this questionnaire shows that the investor is in fact accredited, which allows the company to file a private placement exemption with the SEC. More than likely, a company will file a Form D, under Regulation 506(D), with the SEC to fit the exemption. The Startup Garage provides a sample Investor Suitability Questionnaire; however, to ensure it fits your customized needs, it is important to contact your lawyer before issuing a questionnaire.
Investors’ Rights Agreement (IRA)
An IRA is usually entered into by venture capitalists/investors and the startup during a venture capital financing round. The IRA includes rights like: information rights (i.e. access to the company’s financials), registration rights, contractual “rights to first refusal” (or other pre-emptive rights), and the specific closing conditions required by the investor(s).
Shareholder & Board Written Consents
This document explicitly illustrates the board’s approval of important transactions, e.g. the Series A financing round. Your company’s corporate secretary (whether in-house or outside counsel) should prepare this document in advance of the board’s voting meeting.
Additionally, the Board must ensure that the Written Consent of Stockholders is completed to document the shareholders’ approval of the transaction.
To recap, we covered the following documents for a Series A:
- Term Sheet
- Amended and Restated Certificate of Incorporation
- Preferred Stock Investment Agreement
- Investor Suitability Questionnaire
- Investors’ Rights Agreement
- Shareholder Written Consent Form
- Board Written Consent Agreement
As a reminder, fundraising is a complex process and requires sophisticated business attorneys to ensure the transaction is done right. That’s a wrap, folks!