Gardner Leader

Funding Your Business Through Venture Capitalists

The credit crunch means that many companies will need to look at different sources of funding.  Derek Rodgers of Gardner Leader solicitors in Newbury looks at some of the common features involved where funding is obtained from a venture capitalist (‘VC’).

A VC will usually invest in two ways: by putting up some money to acquire shares in the company or by lending, and often it will be a combination of both.

The company will be expected to sign up to a number of documents to protect the VC’s investment – the protections will include restrictions on the management of the company while the VC investment remains in place, security over the company’s assets and provisions to ensure the VC can exit from the investment when the time is right.

The investment agreement

This will document the amount that the VC is putting into the company, how the investment is made up (e.g. part loan and part equity) and the shareholding it is to get in return.  It will also set out the terms of any loan (although this may sometimes be included in a separate loan agreement or instrument).  It will give the VC the right to appoint a director to the board and will restrict what the company is able to do without first obtaining the VC’s consent, for example by setting a limit on the amount of capital expenditure in any year.  It will also contain warranties – statements of fact by the shareholders and/or directors which, if they turn out to be untrue, can form the basis of a claim by the VC if it suffers loss as a result.

The Articles of Association

The company will be required to adopt new Articles of Association to embed certain of the VC’s rights in the company’s constitution.  The new Articles will set out any special rights for the class of shares which the VC is to own – dividend rights, special voting rights (for example, giving enhanced votes called ‘swamping rights’ in default situations so that the VC can outvote other shareholders) and any redemption rights which may apply.  The articles will also contain ‘drag and tag’ rights to ensure that in certain circumstances a sale of the company cannot be blocked by unwilling shareholders if a purchaser is found who is prepared to make an offer for all the shares, and also to prevent a sale of a majority interest without an offer also being made to purchase the VC’s shares.

The debenture

A debenture is a form of legal charge which gives the VC security over the company’s assets which it can enforce if there is default in repaying the VC’s loan.  If the company’s bank already has security in place, there will usually also be a deed of priority or intercreditor deed to regulate the competing rights of the VC and the bank.   

Derek Rodgers acts for a number of venture capital funds, as well as for companies which have obtained such funding, and is recommended in Legal 500.

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