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Outline of an Investment Agreement
What follows is a detailed outline of the contents of a venture investment agreement. It illustrates the structure and content of an agreement but does not detail current regulatory requirements.
The main sections of a typical agreement are briefly described, and many of the terms that might appear in each section are noted. However, not all of the terms listed will appear in an investment agreement. Venture capital investors select terms from among those listed (and some not listed) to best serve their needs in a particular venture investment situation.
This section of the agreement defines the basic terms of the investment. It includes descriptions of the:
a. Amount and type of investment.
b Securities to be issued.
c. Guarantees, collateral subordination, and payment schedules associated with any notes.
d. Conditions of closing: time, place, method of payment.
When investment instruments are involved that carry warrants or debt conversion privileges, the agreement will completely describe them. This description will include:
a. Time limits on the exercise of the warrant or conversion of the debt.
b. Price and any price changes that vary with the time of exercise.
c. Transferability of the instruments.
d. Registration rights on stock acquired by the investor.
e. Dilution resulting from exercise of warrants or debt conversion.
f. Rights and protections surviving after conversion, exercise, or redemption.
2. Preconditions to Closing
This section covers what the venture must do or what ancillary agreements and documents must be submitted to the investor before the investment can be closed. These agreements and documents may include:
a. Corporate documents; e.g., bylaws, articles of incorporation, resolutions authorizing sale of securities, tax status certificates, list of stockholders, anddirectors.
b. Audited financial statements.
c. Any agreements for simultaneous additional financing from another source or for lines of credit.
d. Ancillary agreements; e.g., employment contracts, stock option agreements, keyman insurance policies, stock repurchase agreements.
e. Copies of any leases or supply contracts.
3. Representations and Warranties by the Venture
This section contains legally binding statements made by the venture's officers that describe its condition on or before the closing date of the investment agreement. The venture's management will warrant:
a. That it is a duly organized corporation in good standing.
b. That its action in entering into an agreement is authorized by its directors, allowed by its bylaws and charter, legally binding upon the corporation, and not in breach of any other agreements.
c. If a private placement, that the securities being issued are exempt from registration under the Securities Act of 1933 as amended and under state securities law and that registration is not required under the Securities Exchange Act of 1934.
d. That the capitalization, shares, options, directors, and shareholders of the company are as described (either in the agreement or an exhibit).
e. That no trade secrets or patents will be used in the business that are not owned free and clear or if rights to use them have not been acquired.
f. That no conflicts of interest exist in their entering the agreement.
g. That all material facts and representations in the agreement and exhibits are true as of the date of closing (includes accuracy of business plan and financials).
h. That the venture will fulfill its part of the agreement so long as all conditions are met.
i. That any patents, trademarks, or copy rights owned and/or used by the company are as described.
j. That the principal assets and liabilities of the company are as described in attached exhibits.
k. That there are no undisclosed obligations, litigations, or agreements of the venture of a material nature not already known to all parties.
L That any prior-year income statements and balance sheets are accurate as presented and have been audited and that there have been no adverse changes since the last audited statements.
m. That the venture is current on all tax payments and returns.
4. Representations and Warranties by the Investor
This section contains any legally binding representations made by the investor. They are much smaller 'in number than those made by the company. The investor may warrant:
a. If a corporation, that it is duly organized and in good standing.
b. If a corporation, that its action in entering into an agreement with the venture is authorized by its directors, allowed by its bylaws and charter, legally binding upon the corporation, and not in breach of any existing agreements.
c. If a private placement, that the stock being acquired is for investment and not with a view to or for sale in connection with any distribution.
d. The performance of his or her part of the contract if all conditions are met.
5. Affirmative Covenants
In addition to the above representations and warranties, the company in which the investor invests usually has a list of affirmative covenants with which it must comply. These could include agreeing to:
a. Pay taxes, fees, duties, and other assessments promptly.
b. File all appropriate government or agency reports.
c. Pay debt principal and interest.
d. Maintain corporate existence.
e. Maintain appropriate books of accounts and keep a specified auditing firm on retainer.
f. Allow access to these records to all directors and representatives of the investor.
g. Provide the investor with periodic income statements and balance sheets.
h. Preserve and provide for the investor's stock registration rights as described in the agreement.
i. Maintain appropriate insurance, including keyman insurance with the company named as .beneficiary.
j. Maintain minimum net worth, working capital, or net assets levels.
k. Maintain the number of investor board seats prescribed in the agreement.
Z. Hold the prescribed number of directors' meetings.
m. Comply with all applicable laws.
n. Maintain corporate properties in good condition.
o. Notify the investor of any events of default of the investment agreement within a prescribed period of time.
p. Use the investment proceeds substantially in accordance with a business plan that is an exhibit to the agreement.
6. Negative Covenants
These covenants define what a venture must not do, or must not do without prior investor approval; such approval not to be unreasonably withheld. A venture usually agrees not to do such things as:
a. Merge, consolidate with, acquire, or invest in any form of organization.
b. Amend or violate the venture's charter or bylaws.
c. Distribute, sell, redeem, or divide stock except as provided for in the agreement.
d. Sell, lease, or dispose of assets whose value exceeds a specified amount.
e. Purchase assets whose value exceeds a specified amount.
f. Pay dividends.
g. Violate any working capital or net worth restrictions described in the investment agreement.
h. Advance to, loan to, or invest in individuals, organizations, or firms except as described in the investment agreement.
i. Create subsidiaries.
j. Liquidate the corporation.
k. Institute bankruptcy proceedings.
L Pay compensation to its management other than as provided for in the agreement.
m. Change the basic nature of the business for which the firm was organized.
n. Borrow money except as provided for in the agreement.
o. Dilute the investors without giving them the right of first refusal on new issues of stock.
7. Conditions of Default
This section describes those events that constitute a breach of the investment agreement if not corrected within a specified time and under which an investor can exercise specific remedies. Events that constitute default may include:
a. Failure to comply, with the affirmative or negative covenants of the investment agreement.
b. Falsification of representations and warranties made in the investment agreement.
c. Insolvency or reorganization of the venture.
d. Failure to pay interest or principal due on debentures.
This section describes the actions available to an investor in the event that a condition of default occurs. Remedies depend on the form an investment takes. For a common stock investment, the remedies could be:
a Forfeiture to the investor of any stock of the venture's principals that was held in escrow.
b. The investor receiving voting control through a right to vote some or all of the stock of the venture's principals.
c. The right of the investor to "put" his stock to the company at a predetermined price.
For a debenture, the remedies might be:
a. The full amount of the note becoming due and payable on demand. 6. Forfeiture of any collateral used to secure the debt.
In the case of a preferred stock investment, the remedy can be special voting rights (e.g., the right to vote the entrepreneurs' stock) to obtain control of the board of directors.
A number of other clauses that cover a diverse group of issues often appear in investment agreements. Some of the more common issues covered are:
a. Who will bear the costs of closing the agreement; this is often born by the company.
b. Who will bear the costs of registration of the investors' stocks; again, the investors like this to be borne by the company for the first such registration.
c. Right of first refusal for the investor on subsequent company financings.