Equity Financing Documents
There are several standards documents employed in the equity funding transaction. Many of these documents surround the formation of a new business entity (or modification of the existing entity), governance procedure, and the actual purchase and transfer of an ownership interest. Below are brief explanations of the most common documents involved in the Equity Financing Transaction.
- Amended and Restated Certificate of Incorporation – If this is a seed round or series A financing, the company may reorganize in an attempt to clean up the ownership structure. The common trend is to reorganize in Delaware, given the manager-friendly provisions of Delaware law. In any event, the articles of incorporation may be amended to include the provisions desired by investors. In a seed funding round you will likely see an authorization of the common and preferential class of shares issued in the financing. Further, there will be a new board of directors, with the investors represented.
- Stock Purchase Agreement – The stock purchase agreement will contain all of the terms previously negotiated in the term sheet. Later stage financing becomes increasingly demanding and will include increased representations and warranties and closing conditions. Further, the agreement may require legal certifications and a legal opinion regarding company status and compliance.
- Investors’ Rights Agreement – The investor rights agreement will contain the protective provisions prescribed for investors. These may include participation rights, information rights, redemption rights, registration rights, and other investor-specific control provisions. If the shares are capable of conversion into a future round of equity shares, this agreement will outline the conversion rights (as the shares will technically be exchanged with the corporation for the new class of shares).
- Management Rights Letter – The venture capital firm wants to avoid becoming subject to regulation under the Investment Company Act. To avoid this, the VC firm must have certain rights to control or decision making in the business. The management rights letter will establish this authority and qualify the startup as an venture capital operating company.
- Term Sheet – The term sheet is the document memorializing the initial agreement between the parties. It will contain the major terms that are incorporated in all of the other documents. The term sheet may also include elements that do not make it into the final agreements. For example, it is common for term sheets to include a cap or maximum that the startup company will contribute toward the cost of the investor’s legal counsel working on the investment.
- Employment Agreements – As part of the financing arrangement, the company may be reorganized. In such a situation, the founders will receive a large percentage of the company as part of the reorganization. Likewise, the investors receive a large percentage of the shares. If the founders will continue on in the business, a percentage of their ownership may be subject to a vesting schedule. The vesting schedule is used to incentivize the founders to continue to perform (see our Vesting Schedule lecture for more information.).
- Right of First Refusal and Co-Sale Agreement – The investors may desire the inclusion of a right of first refusal and co-sale rights regarding the sale or transfer of shares by any shareholder. Right of first refusal allows the company the first right to purchase shares at the price offered by a third-party purchaser. Co-sale rights allow the holder of shares to participate at a given percentage in any sale or transfer of a shareholder’s interest. These agreements protect the closely-held nature of the business.
- Voting Agreement – Often a condition to investor funding is the execution of a shareholder agreement addressing specific matters. The issues addressed in the shareholder agreement could concern voting for directors, sales or mergers of the corporation, amendment of the articles or bylaws, etc.
- Schedule of Exceptions – The Stock Purchase Agreement contains varies representations and warranties from the entrepreneurs to the investors. The schedule of exceptions allows the entrepreneurs to make extensive disclosures about the company. These disclosure create constructive knowledge for the investors. As such, they cannot later claim that they were not aware of some fact and attempt to back out of the deal or bring a lawsuit against the founders.
- Legal Opinion – The legal opinion is a certification from the company’s attorney stating that all of the corporate governance affairs are in order and that the funding transaction does not run afoul of the corporate governance documents or federal or state law.
- Board Consent – The board will have to initiate and approve the action of selling equity in the corporation. The board will generally take formal action through a unanimous consent in lieu of meeting vote.
- Stockholder Consent – As with other major transactions, the shareholders will have to approve the action of selling equity in the corporation. Like the board consent, all shareholders will approve the action via unanimous consent in lieu of meeting vote.
Officer’s Certificate – The president or other officer will act on behalf of the corporation in negotiating and carrying out the equity funding process. The officer’s certificate attests that the officer has authority to act on behalf of the corporation in this manner.
- Secretary’s Certificate – The secretary must certify the authenticity of corporate records. This includes any board actions as originating through appropriate corporate governance procedure.
Good Standing Certificates – The company will be required to provide a certificate from the state demonstrating that it is in good standing under the state law.
Indemnification Agreements – The officers and directors of the corporation will seek indemnification from liability for the actions taken for the corporation.
- Confidential Information and Invention Assignment Agreement – These documents are relevant when the corporation is reorganizing. In that case, the parties will make certain that all intellectual property ownership interests are transferred to the corporation. Often, the IP constitutes the strategic advantage of the company. Failing to adequately transfer the IP can greatly affect the value of the company. As such, the parties will sign agreement concerning the disclosure of confidential information and the assignment of IP to the business.
- Stock Certificates – Not all companies actually issue physical stock certificates. If they do, however, these certificates must comply with state law and be issued in accordance with internal governance procedure.