Tax, Accounting and Legal Consultancy in Barcelona

93 218 14 41
Request consultation

Investment Agreement: Types, Parts, Actions

An investment agreement is a binding contract that specifically regulates the participation of an investor in a start-up or company.

These special contracts contain important information for both sides and ensure legal certainty for the investors and the founders. All possibilities can be clarified through these contracts.

If you are planning to invest in Spain, we also recommend you to read our article about Investing in Spain: Advantages and Disadvantages.

In the following, we present the types, functions and components of investment agreements.

Types of investment contracts

There are different types of investment agreements. The most common are:

  • Shares purchase agreement;
  • Share option agreement;
  • Convertible debt agreement;
  • Restricted share agreement;
  • Deferred consideration.

Share Purchase Agreement

A share purchase agreement is a type of investment contract in which a person, the investor, buys a certain percentage of the share capital of a company in exchange for capital.

After the investment transaction, the investor becomes a shareholder in the company.

Share option agreement

Stock option agreements can be either non-qualified or qualified stock options.

A stock option gives you the ‘right’ to buy shares in a company at a future date at a price set at the time the option is granted.

The purpose of a stock option is to allow a person to buy shares in a company in the future at a fixed price.

If the value of the company’s shares increases, he can exercise his options and buy ordinary shares for less than the market value of the shares.

Convertible bond agreement

A convertible bond agreement is signed when a person or company agrees to lend the company money but has the option to convert the loan into a stake in the company.

The convertible debt agreement specifies who has the right to convert the debt into equity.

In some convertible debt agreements, the lender may request a repayment of the loan or choose to convert the loan (or principal and interest) into company securities.

Restricted share agreement

A restricted share agreement is a type of investment agreement in which a company agrees to issue shares to an individual in return for his or her time and effort on behalf of the company for a certain period.

If the individual does not contribute for a certain period, they are not entitled to the shares.

Deferred consideration

Deferred consideration is not in itself an ‘investment agreement’ as the person does not receive an equity interest in the company.

A deferred compensation agreement is when a person agrees to work for the company today in exchange for future remuneration, salary or bonus.

Investment agreement – components

The investment agreement contains certain provisions that relate to various aspects of the participation.

These include:

  • the type of participation;
  • the start and the minimum term of the participation;
  • the amount of the investment;
  • the profit share;
  • the actions that each party must take to complete the investment.
  • warranties and representations;
  • the exit conditions in the event of a dissolution of the participation.

In addition, various control and information rights are agreed upon.

Concerning the type of individual contract components, a distinction can be made between directly payment-related contract clauses and only indirectly payment-related clauses in the investment contract.

The directly payment-related clauses of the investment agreement have a direct effect on the distribution of current income and the possible proceeds from a later sale of the company (so-called exit).

On the other hand, the indirect payment-related clauses of the investment agreement define control rights in a broader sense as well as the contracting parties’ possibilities to influence the business policy.

Thus, they ultimately also serve the purpose of shaping and securing asset positions.

Investment Tranches – payment

In the case of investments in companies, payments are usually made in tranches, each of which is measured by the achievement of agreed milestones.

Typically, these milestones are measured by, for example, various stages of development of one or more products or a company’s commitment to undertake new developments. Investors can usually waive milestones or other closing conditions if they are not met.

Pre-investment actions

Investors may ask that certain actions must be met before the first part of the investment is completed. These actions may include:

  • Completion of business due diligence;
  • Submission of a business plan and accounts;
  • Obtaining all necessary tax approvals;
  • Having the necessary authority to issue new shares to investors in the investment and adopting new articles of association. This is likely to require shareholder resolutions, which may affect the timing of completion of the investment, depending on how quickly these resolutions can be passed;
  • The issue of shares or options to the founders and key management personnel;
  • Full transfer to the company of the necessary intellectual property rights of the founders or others; and
  • Taking out appropriate insurance, such as key persons and senior management liability insurance.

Warranties

Incidentally, investment contracts also contain guarantees on certain key economic data of the company. Since the investor does not know all the details of the company, he tries to protect himself from so-called window-dressing: In this process, founders and former shareholders make themselves and the company “prettier”, i.e. more successful than they are, to obtain financing.

A tried and tested means of VC investors at this point are no-fault assurances by the founders/company on certain entrepreneurial key figures concerning the:

  • company law;
  • financial;
  • tax;
  • economic;
  • circumstances of the start-up. The object of the guarantee is the accuracy, completeness and materiality of the information provided to the investors.

Typical warranties are as follows:

  • Business plan;
  • Shares and company registration;
  • Commitments and contracts;
  • Directors and employees;
  • Tax.

Investor & founder rights

For the investor, the investment contract regulates the disbursement of the financing sum and their co-determination rights.

Each company defines the framework conditions for the investor’s participation in its individually tailored participation contract.

Special rights are stipulated in the investment contracts for the investors. The founders or managing directors of the company must guarantee certain things for their capital investment.

On the one hand, there are reporting obligations per quarter on the part of the company to inform the investors about their business activities, including a list of turnover, gross profit or the gross profit achieved by a company in a certain period, but also successes, challenges, events and the next planned steps.

On the other hand, the investors have certain control and information rights that the founders and companies must serve. The information must be provided to the investors beyond the applicable legal requirements.

Restrictive covenants

Restrictive covenants or in other words so-called non-competition agreements are designed to prevent founders from competing with the company’s business during their participation in the company and even after their participation has ended.

Restrictive covenants are usually contained in both the service agreement and the investment agreement.  However, restrictive covenants in an investment agreement usually have greater legal force than in a service agreement because the founders enter into them as shareholders (rather than as employees) as part of their compensation for the investment.

Conclusion

The investment agreement is a big deal. However, you should take special care, because getting an investor is a serious matter. Many founders make the mistake of thinking that the biggest work is finding an investor.

But the work is just beginning. Now it is important to define the relationship between the company/start-up, the founder and the investor in the investment contract and then to live this relationship.

The better the investment contract is prepared and formulated to reflect this relationship, the fewer problems there will be later when a situation arises in which it is precisely this contract that matters.

 

If you seek legal advice regarding an investment agreement, please contact our tax advisors in Barcelona for a entrepreneurs and startup consultancy.

 

You May Be Also Interested in

    Fill out the form to contact us!

    Basic information on data protection: The data controller is GM Tax Consultancy, S.L. The purpose is to attend to the request or query formulated by the interested party. According to the legal conditions, you have the right to access, rectify and delete data, to the limitation of its processing, to oppose its processing and to its portability. You can consult additional and detailed information about Data Protection in this link.