Legal Aspects of Venture Investments

Because of the nature of emerging business, the parties involved in structuring and implementing venture investment documentation must be sensitive to the changing objectives and requirements of the business and the stakeholders.

Start-up investments involve a unique process in which investors develop a working relationship with the entrepreneur: it is one in which cooperation and mutual respect must be stressed. Both sides should be aware of the objectives and concerns of the parties.

The company, founders and other initial shareholders desire to raise an appropriate amount of capital at a favourable price, so as to minimize the amount of dilution they suffer in connection with funding the business. Furthermore, they want to retain sufficient control over company management and avoid unnecessary restraints on the transfer of their shares. Founders also do not want to restrict their ability to seek additional financings or be acquired in the future.

Investors, on the other hand, expect to participate in the company’s equity appreciation. They also expect to develop a mechanism to obtain liquidity for the investment, either once that appreciation has occurred or in the event the investment does not succeed. Furthermore, they wish to protect the investment from any ‘downside’ event which may occur in the future. For these reasons, investors will obtain a degree of control and influence over management and its policies. Investors will also require ongoing financial and other information about the company, and need to have access to the company and its management personnel in order to monitor progress.

Given that each transaction has to reflect the particular chemistry between the entrepreneur, the investor and the company involved, there is no absolute model for the legal documentation for each investment transaction. There is some standardization in the industry as to the forms and contents of documents. Each deal must then be properly tailored to reflect the unique character of the company, the interests of the entrepreneur, and the requirements of the investors.

The attachments provide an overview of the venture capital documentation frequently included in financing emerging companies. For participants in the venture investment, a thorough understanding of the varieties of transactions that are available and the ability to change corporate structure based on preferred shares, convertible debt, options, warrants and other rights relating to the equity portion of the balance sheet is essential.