The disruptive nature of sharing economy business models means many businesses in the sector operate in challenging regulatory environments. While it is an attractive area for venture capitalists, they will of course want to know that their investments are on a sound legal footing, and so sharing economy businesses need to be prepared to discuss business and regulatory challenges as part of the VC fundraising.
As advisors to a range of sharing economy companies seeking venture capital investment, we see the same issues crop up repeatedly. However, with some forward planning, it is possible to address the most common issues in advance. Here are our top 10 tips on how best to prepare for a fundraising.
1. Due diligence
Once the decision to seek VC funding has been taken, start to collate scanned copies of key documentation (e.g. material customer/supplier contracts, management service agreements) and organise them in a logical folder structure within an online data room or shared folder. This will help ease some of the time pressures that inevitably will arise when the process kicks off and the management team are required to balance the demands of the business with the investment process.
Collecting this information and carrying out a basic internal legal audit will also provide an opportunity to deal with any issues/gaps in information identified in advance, rather than having to deal with these issues later in the process when they are identified by the investor through its due diligence (at which point those sorts of issues tend to be more disruptive). In particular, for those sharing economy platforms which operate in a challenging regulatory environment, steps should be taken to address, mitigate or prepare to discuss such challenges with investors.
2. Intellectual Property
An Intellectual Property (IP) audit should be carried out in advance to ensure that the company has ownership of, or the right to use, all material IP critical to the business, and appropriate steps have been taken to protect such IP.
Where the IP should be owned by the company, ensure that the employees or contractors who have generated the IP have correctly assigned ownership to the company via their employment/services contract or by way of a separate written assignment. Do not rely on an implied understanding that the IP was created for the company – the assignment must be in writing. IP is likely to be a key area of focus for an investor’s due diligence and being able to demonstrate that you are on top of your IP will help gain an investor’s trust and confidence, whilst ensuring that valuable assets are protected.
3. Statutory books and Companies House filings
Make sure you know where your statutory books are (or, if they are lost, reconstitute them) and make sure that they are up to date. If you are unsure about what records you need to maintain or how to update them, speak to a lawyer (rectifying mistakes in the registers may require a court order, so it is important to get this right). Also, make sure your Companies House filings are up-to-date and the filings that have been made are correct. Your statutory books and Companies House filings will be reviewed by an investor as part of their due diligence and having accurate records and filings will avoid the need to explain and rectify errors.
4. Managing your existing stakeholders
Consider what consents and signatures may be required from existing shareholders, how you’re going to deliver them in order to complete the transaction and the timing and nature of shareholder communications. For example, it may be helpful to obtain powers of attorney so that one person can execute documents on behalf of a number of shareholders. Get legal advice about this early on in the process and remember that the company will almost certainly have confidentiality obligations to investors.
5. Employee and Founder Equity
Whilst investors are frequently happy for an option scheme to be implemented within a few months of closing the investment round, they will often want you to agree to key terms before they invest. An institutional investor may require the founders to “vest” or “re-vest” all or a part of their equity, and may require you to give up some of your vested equity if you leave the company. Be prepared to have these conversations.
6. Term sheets
The first formal document you’ll be asked to sign as part of the process is a term sheet. Once something has been agreed in a term sheet, it is difficult to renegotiate and, although it may not legally binding, it is binding at least in honour. We recommend that you always seek advice from a lawyer (or someone experienced in VC fundraisings) before you sign the term sheet so that you understand exactly what you’re being asked to agree.
Be aware of the tax implications of the proposed investment. In particular, where you have raised funding from investors in the past who have sought to qualify for certain tax reliefs (e.g. EIS/SEIS) it will be important to consider whether the terms of the proposed investment will have an impact on the qualifying status of those investments as the rules are notoriously complex. It may be possible to seek comfort from HMRC in advance and, in these circumstances, specialist tax advice is recommended.
8. Roles and responsibilities
You should decide with your co-founders or management team who is going to focus on the fundraising, and who is going to run the business during that time. Give someone primary responsibility for dealing with advisors and investors and for agreeing the deal. There will be times when everyone’s input is needed, but make sure that the time pressures involved in completing a fundraising do not have an adverse impact on the business.
You should also agree a clear, achievable timetable with your investors and the advisors on the transaction. Set deadlines with the investors for the delivery of long-form documents (which will generally be prepared by their lawyers) and the completion of their due diligence. This is best dealt with at term sheet stage.
Finally, start talking to advisors – in particular, accountants and lawyers – early. An advisor who is experienced in VC fundraisings will provide invaluable assistance in helping you navigate the process, tell you what to expect and be on hand to help you sort out the issues which will invariably arise during the course of the process.
Want to know more about VC term sheets and VC bridging rounds? Read more here.
This article is the last in a series of six weekly articles on the legal issues affecting the sharing economy. Click here to read the last update on practical steps to address data privacy and cyber security risks.
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Contact: Simon Jones
Tags: Venture capital