The first equity raised for many technology companies in the UK is a friends and family round. Ranging from £50,000-£250,000 (sometimes more), this is often the first exploratory seed money to come into the business. It’s the time to start building.
The UK Government has in place the excellent seed enterprise investment scheme (SEIS) (for the first £150,000 for qualifying companies) and enterprise investment schemes (EIS) which provide investors with significant tax advantages. Under SEIS and EIS, investors are entitled to a tax rebate at the time of investment and protection from inheritance tax and capital gains. These features can make this a very attractive investment stage for many investors, although it is difficult to overstate the risks at this embryonic stage of any new business venture. The tax incentives are there as a reward for those willing to put their funds at risk in this way. It is also often a chance for friends and family to show support for a project. Money that loves you is inherently less critical than the cold hard investment of third parties, and whilst it can provide a much needed boost to a fledgling idea, it is important for founders to consider carefully whether they are comfortable accepting funds from friends and families given the potential risks.
When it comes to putting paperwork in place, early stage investors rarely use their own legal advisers in our experience. The best position for the investee company to put forward in its documentation therefore is one that is simple, in line with market standards and easy for investors to read, understand and accept.
It should also offer a reasonable level of protection for both sides and not exploit the lack of advisors on the other side. However, the documents are very likely to be reviewed and in many cases replaced at the time of the next investment round, meaning that over-investing in the documents at this stage is not desirable. Keeping it simple and reasonably standard is the order of the day, something we as a firm pride ourselves on.
As with all legal processes however, underinvesting at this stage can be disastrous, leaving projects exposed to personal disputes, departing founders and stubborn minority shareholders preventing progress without justification. Here are five things you need to consider carefully when putting together any founder or investor agreements as these can save you a lot of time, effort and heartache!
In our view and experience, its particularly important to have a clear and well drafted agreement if the investors really are friends and family. Disputes at this stage can spell an end to the business, and be damaging to the relationships with those who supported you when you needed it most. Using clear, transparent and comprehensible documents is key to making these relationships function.
- A clear understanding of the intended process the company is going to follow –in particular, if the company is expecting to go through multiple investment rounds then you should clarify that – its remarkable how often smaller angels are surprised by further funding rounds.
- A clear commitment from the founder(s) as to what outside interests they will hold, and how they will proceed in relation to personal investment, time commitment and salary.
- An agreement as to what will happen to the shares of any key team member or founder who leaves the business within a reasonable period of time (most likely three or four years). You don’t want to carry someone on 20% of the equity through the life of the business.
- A commitment from the company to maintain its SEIS / EIS eligibility during the key 3 year period.
- Drag along and tag along rights allowing the founders to drag the shareholders into a sale and allowing the minority shareholders to tag along in an exit.
The terms may seem standard but assembling all into one document is a precise and detailed task. We have spent several years developing our process to be able to provide the first draft documents for these rounds swiftly, consistently and cost effectively. We would love to discuss how we can assist you get your first money into your business and start building.