When considering investing in an existing business the investor does not have the same detailed knowledge of the company that the existing owners do. In order to safeguard the investors interests an investment agreement is often put in place which lays out the terms for such investment. The investor receives certain assurances by the existing shareholders and/or management team that they will continue to operate the business as a going concern, provide adequate working capital and pay dividends etc..
The Investment Agreement can be used to protect both parties from each other if there are any disputes or disagreements between them. This is especially important when one party has more money than the other. If this happens then it may be difficult for the smaller party to get their money back. An example would be where a larger shareholder wants to buy shares from a smaller shareholder
The investor can be an existing shareholder of the company and therefore may already have entered into a shareholders’ agreement with the company and its shareholders at an early stage pre-investment, or it can be a new investor.
What is an investment agreement?
An investment agreement is a legal document that sets out the rights and obligations of all parties involved in an investment transaction. It is usually drafted after a deal has been agreed upon but before the actual transfer takes place.
It is common practice for companies to enter into agreements with potential investors prior to making any investments. These agreements set out the conditions under which the investor will make his or her investment. They also outline how the company will manage the investment and what returns the investor expects or conditions for exit.
Why is an investment agreement important? The main purpose of an investment agreement is to ensure that the investor’s interests are protected during the course of the investment.
This means that the investor should receive some assurance that the company will remain solvent and able to meet its obligations to the public (such as paying suppliers). If the company goes bankrupt, the investor will most likely not receive any of the funds he or she invested so trying to ensure that the company is well-managed before investing is key.
How does an investment agreement work?
When drafting an investment agreement, you need to consider several factors:
- The type of investment being made. Will the investor be buying equity or debt instruments?
- What is the size of the investment? Is it a small amount or a large amount?
- How much time is left until the end of the financial year?
- Are there any special circumstances that might affect the value of the investment?
- Who owns the company? Do the current shareholders want to sell the company to the investor?
- Does the company have any outstanding loans?
- What is the relationship between the investor and the company?
What are the main provisions according to UK law that should be included in the investment agreement?
There are four main areas covered by an investment agreement:
- The terms of the investment
- The management of the company
- The protection of the investor’s interest (with restrictions imposed on the management)
- The exit options for the investor or management Each of these areas has specific requirements.
Terms of the investment
The first area covered by an investment agreement is the terms of the investment. There are two types of terms:
- The purchase price – The total amount paid by the investor for the shares.
- The return on the investment – The rate of return the investor receives from the company.
This includes both the capital appreciation and any income generated by the company.
Management of the company
The second area covered by an investment contract is the management of the company. In this section, you can include details about how the company will use the money received from the investor. You can also state whether the company will pay dividends to the shareholders (or the conditions under which it would do so, i.e. after all debt is repaid or when EBITDA is a certain multiple of interest expense, etc.).
Protection of the investor’ s interest
The third area covered by an investment is the protection of the investor’s interest. This section covers all the issues related to the investor’s rights and responsibilities. Here you can cover such things as:
- The right to inspect the books
- The right to audit the accounts
- The right to terminate the contract
- The right to withdraw at any time
- The right to sue the company for damages
Finally, the exit options for the investor or management. Forced buy-out of the investor’s shareholding, or voluntary sale of the business to another party. Often the management of the company will insist on a forced buy-out of the investor within a certain period of time and for a set price. Alternatively, an exit might be limited to an IPO or a sale of the entire share capital of the company, which raises the issue of what input and how much control will the investor have in that process.
Who needs to sign an investment agreement?
An investment agreement must be signed by all parties involved in the transaction. These parties include the following:
- The company
- The investors
- Any other person providing services to the company
If the company is not incorporated, then the prospective directors must sign the agreement. If they do not, then the general partners (if applicable) must sign the agreement. If the company is already trading, then the existing shareholders must sign the agreement.
What happens if I don’t sign my investment agreement?
In most cases, it is very important that you sign your investment agreement before investing in a company. Some companies may try to force you to sign the agreement after the investment is complete. For example, some companies may say that they cannot give you access to your investment until you sign the agreement. It is possible that the company could claim ownership of your shares if you do not sign the agreement or the appropriate formalities have not been complied with.
How does one get started?
Before getting involved in any type of investment, it is advisable to study the legal requirements of the jurisdiction in which you intend to invest. Getting a lawyer to help you draft or review an investment agreement will reduce your risk considerably.
We, at Chic Consultants, have acted for both companies looking to attract investment and investors. We most recently advised on an investment agreement for an £8 million investment round in an AI and media start-up.