SUMMARY
Fundraising should always be accompanied by two things: due diligence and proper structuring
It is critical for each entrepreneur to determine which type of funding is best suited for their company's development by thoroughly understanding the startup funding system
Read on to learn about the various types of legal agreements that a founder must have a firm grasp on while fundraising
Fundraising should always be accompanied by two things: due diligence and proper structuring. While there are several aspects to structuring, one of the most important is the agreement or instrument that is being executed for the fundraising.
An investment agreement generally defines the terms and conditions of the fundraise, the rights and obligations conferred on each involved party, the method by which all parties can exit, and so on. These clauses safeguard the interests of the company, its promoters, and incoming investors.
There are different types of agreements that can be executed between the parties:
Investment Agreement
It is a contract signed between the founders of a startup and potential investors interested in purchasing the company’s stock. These potential investors could be external investors or existing shareholders of the company.
Term Sheets
Potential investors create a term sheet for the company that details how they intend to use their investment. Term Sheets are non-binding documents that serve as blueprints for the company’s relationship with its investors. They are followed up with a definitive, binding agreement.
Shareholders Agreement
It is an agreement that gives the company’s shareholders and members certain rights and obligations. It ensures that all partners are treated equally in terms of asset distribution, profit and loss sharing.
Subscription Agreement
It is an agreement between the investors and the entrepreneurs where they agree to buy and sell a certain number of shares at a specific price. Both parties are expected to fulfil their conditions based on the predetermined price in this agreement.
Share Purchase Agreement
It is an agreement in which investors agree to purchase a certain number of shares in a company at a specific price under certain terms and conditions. It is a more formal agreement than a subscription agreement because it requires the investors and the company involved to write down their information (a subscription agreement is more discreet in nature).
There are certain differences between a share purchase agreement and a subscription agreement:
- An investor purchases shares from another investor or shareholder of the company in a share purchase agreement, whereas an investor purchases shares from the company in a subscription agreement.
- A share purchase agreement does not dilute the company’s existing shareholders’ shares, whereas a subscription agreement causes the company to issue additional shares at fixed prices, diluting the shareholders’ existing shares.
Business Loan Agreement
It is an agreement in which the startup borrows money from banks at a fixed interest rate. Banks earn money through interest rather than profit percentages or company shares. Regardless of the status of their business, the company is obligated to repay the money borrowed from the bank.
Asset Purchase Agreement
It is an agreement in which the startup aims to raise funds by selling the company’s assets, including fixed assets such as buildings and machinery. The entire company can be sold in asset purchase agreements; in such cases, these agreements are known as acquisition agreements.
Debentures
These are movable properties of a company that it issues to others for a set period of time at a fixed interest rate in order to raise funds without using collateral or giving up equity.
Raising Funds Wisely
Raising funds wisely is an important factor in the growth of a startup. Founders have quite a few options for raising funds.
However, each entrepreneur must determine which type of funding is best suited for their company’s development by thoroughly understanding the startup funding system and then making an informed decision.
