Whatever the structure of investments into private limited companies, it is always advisable for investors and company founders to enter into an investment agreement. An investment agreement is a legally binding contract that outlines the terms of an investment between an investor and a company, and also regulates their relationship going forward. Having a clear agreement ensures all parties clearly understand their rights and responsibilities, and helps to minimise conflict going forward.

These agreements are always important. whether the investments are made by individual investors (angel investors), venture capital, private equity or crowdfunding and are often used in conjunction with tax efficient schemes like the Seed Enterprise Investment Scheme (“SEIS”) and the Enterprise Investment Scheme (“EIS”), both of which offer considerable tax advantages for investors in early-stage businesses.

Key Provisions in an Investment Agreement 

Investment agreements typically include several key provisions, which will vary depending on the deal, and the ongoing relationship of the parties.

Investment Amount/Description: Specifies the amount being invested, whether in money, assets, or other forms of value. Bank or other debt may also be arranged by the company alongside equity, so the details of repayment etc. are often set out in the investment agreement.

Equity or Ownership Stake

• Ownership Percentage/Numbers: details of the investor’s, the founder’s and other shareholders’ shares in the company will be clearly set out. 
• Class of Shares: If the investment is in equity, this provision outlines the type of shares (ordinary or preferred) the investor will hold.

Use of Funds: This may specify how the company intends to use the investment funds (e.g., for expansion, R&D, marketing campaigns, etc.).

Investor Rights: This provision will set out any rights that the investor will hold in relation to voting, board representation and information rights, following an investment into the company. It is likely that any investor will want some access to financial information going forward so they can track the performance of their investment. In addition, an Investor director is often appointed a set of reserved matters or vetoes which can only be undertaken by the board with investor and/or founder consent. These may be commercial matters, such as a cap on spending or strategic such as the timing of any further investment or exit.

Exit Strategy: the parties will often agree an intended timeline for an exit, and set out the ways an exit may be achieved. Generally this sort of provision is made on a non-binding basis, as it is difficult to predict the future performance of the company, and when it will be ready for exit. However it is often useful to set out the general gameplan.   

In addition the investment agreement (or the articles of association of the Company ) might also contain tag and drag rights. Drag rights require all shareholders to sell on the same terms, in the event of an offer for purchase accepted by the majority of the shareholders. Tag rights allow all shareholders (including any minority shareholders) the right to exit on the same terms if an offer is made for a majority interest in the company. This prevents an investor or the founder selling out without getting an exit for everybody.

Transfer of shares: An investment agreement may also include some general restrictions on transfer of shares, including the timing and price of any transfer. This may affect transfers to   existing shareholders or to third parties prior to a full exit.

In addition, in the event a founder or key shareholder decides to leave the company before a full exit, an investor, may also want them to offer their shares for sale, this known as a mandatory transfer provision. Who they offer the shares to and at what price would be dependent on the relative position of the parties, but again this can all be catered for in the agreement.

Dividends and Profit Distribution: This provision would set out how profits and dividends will determined. This can be agreed at board level, or can include specific requirements on the company to distribute a percentage of its profits. There may also be a prohibition on dividends for a certain period, say until any debt owing to the investor is repaid.

Anti-Dilution or Preemption Provisions: These provisions protect both the investor and the founders from having their ownership percentage diluted if additional shares are issued in the future.  

Liquidation Preference: This would specify the order of payments in the event of a sale, liquidation, merger, or other exit event. 

Covenants and Restrictions: An investment agreement will usually contain various undertakings from the company and/or the founders to take certain steps (positive obligations) and will usually also outline restrictions placed on the company and /or founders (negative) regarding certain actions, such as not selling assets, taking on additional debt, or changing the company’s structure without the investor’s consent. Other restrictions may include non-compete and non-poach restrictions. An investor may want to be sure that no founders or other key shareholders will leave the company and set up in  competition with the company for a certain period after the investment.

Warranties and Representations

The company and in some cases its founders will usually be required to give warranties to the investor. These are statements regarding the company’s legal status, financial health, and business operations, ensuring there are no significant undisclosed liabilities or issues.

Individual founders may also be asked to warrant their personal position, such as to confirm they are not bankrupt or unable to pay their debts and have capacity to enter into the agreements.

The investor may also make representations about their ability to make the investment, and their understanding of the risks involved.

It is also key that an investor undertake due diligence when making an investment into a company. These will draw out any potential issues and enable the investor to make a clearer decision on the investment. The outcome of a due diligence process will also inform the nature of the warranties that may be required.

Why Investment Agreements are used for SEIS and EIS Investments 

Investment into SEIS and EIS come with a number of criteria, which must be followed to obtain the tax benefits of the schemes. Entering into an investment agreement to protect each of the party’s position, is still advisable, but consideration must be given to ensure compliance with the schemes’ eligibility criteria, which are necessary for investors to qualify for tax relief. 

The agreement specifies the investment structure, such as the type of shares issued and how the funds will be used, while also protecting the investor’s rights, including ownership and exit options. By clearly defining these terms, the agreement ensures both parties meet the requirements of SEIS and EIS, allowing investors to secure the associated tax benefits.

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Investment agreements remain, and will remain a key agreement that clearly outline each party’s rights and obligations and so will serve each party’s interest if there is ever a dispute.

If you would like to discuss any point raised in this article, please get in touch with our corporate team and we would be happy to help.