This phase requires a solid data room, a good lawyer and some time-consuming negotiations. But thanks to high investor interest you are well positioned to have the money on your account within 4-6 weeks. Celebrate!
Intro: Prevent mistakes and keep costs down
You have enough investors to close the round, and the key terms are defined! Sounds as if it’s gonna be a walk in the park from now on.
And you’re right: Compared to the previous phases, this should be a rather easy one. However, there are still many nitty gritty-type things to agree on in the final contract – plus some substantial things, such as founders’ warranties, that can lead to emotional discussions.
Here are a few crucial things for intelligently steering through this phase and closing the round:
- Good relationship with future investors: Make sure you are close to your future investors. Periodic calls – be it to enquire about something related to the contracts, your business, or even for personal reasons – create trust and make it much easier to resolve contractual details during the process. It is crucial to keep investing in these relationships!
- Managing your own lawyer: It should be a given that you are working with a great lawyer with solid startup experience (if not, read this). The clearer you are regarding your needs and the less you involve the lawyer in nitty gritty negotiations, the lower your final bill will be.
- Involvement of other lawyers: Ideally you agree with the new investors to only have one lawyer – this makes things much easier and cheaper. However, especially in later stage rounds, there are typically other investors involved. Coordinate upfront who it will be, and explicitly agree with all new investors to keep costs down.
- Take the lead: Do not let the lawyers take over the process. You should be controlling it. While your lawyer may support you in the negotiation of specific points that are crucial for you, it should be you who defines the key contents and agree over them with the new investors.
- Keep it vanilla: Use standard contracts and keep to them as much as possible. You are not the first startup to do a financing round, and not the first one to do an anti-dilution clause or plan for an IPO. All that stuff has been defined thousands of times – and if you have both an experienced lawyer and experienced investors, you will find standard solutions that are acceptable for both sides.
- Be pragmatic: While investors and their lawyers can be stubborn, some founders can be even worse. The fear of losing a certain control over the startup can be stressful – and this becomes very clear in this phase as you define the details. Relax: slowly losing control is part of building a fast-growing tech company. Discuss with your lawyer what is standard, and go for that.
- Legal cost: We have seen many cases where legal costs exploded in this phase. Depending on complexity, geography and company stage, legal costs should be in the range of USD 5k-50k. Think about setting up a cost cap for the elaboration of all needed documents up to closing – or at least get an estimate from the lawyer(s) and ask for early input in case costs are higher. Such a setup will prevent an ugly surprise.
Work out a first version of the needed contracts
You will want to elaborate a draft of an investment agreement and an updated shareholder’s agreement as quickly as possible.
The Share Purchase Agreement (SPA, also called Subscription Agreement or Investment Agreement) typically defines the closing process, highlights representations and warranties (of founders, the startup and new investors), and describes what happens if any of these representations and warranties is infringed.
A solid Shareholders’ Agreement (SHA) should already be in place. However, in case of an equity round, it needs to be updated. Ideally this is only a few small changes, like updating the cap table. But it could also be a complete overhaul of the document if starting with a clean new version is more straightforward than trying to update the existing version.
Have your lawyer work out a first version of both documents. Discuss the details and the potential points for discussion internally before going out to investors.
- Have your lawyer work out SPA and SHA, and align internally.
Negotiation with investors
A solid SPA/SHA based on the jointly agreed terms should enable a smooth progress. Having said this, we have never seen contracts that are fully undisputed in this phase. The fact that the investor or their lawyer wants to show that they have read the documents alone will result in lots of redline.
One of the new investors will typically take the lead in negotiating these contracts. Having said this, others may want to be involved as well, or at least be updated about the progress. It is up to you (and your lawyer) to judge how to coordinate this. Make sure this point is aligned with each investor upfront: getting back to material points at the very end is highly frustrating for all parties involved.
Investors have much more experience with deal terms than you have. So the best strategy if they get back to you with feedback is to listen, ask questions and understand their points, rather than negotiate. Consolidate all feedback and elaborate an updated version together with your lawyer – most likely accepting certain points and being firm on others.
It typically takes a few rounds until a final version is ready. Both sides will need to accept some clauses they dislike. But soon you will be in the same boat and become able to refocus on business building.
- Warranties: This is a topic that often results in heated discussion. Investors want to be sure that the provided information is true and complete – and if not, get their money back or receive better terms. These warranties typically must be burdened by the founders, who are driving the diligence process. It is not uncommon that the SPA includes a clause where founders must pay a penalty out of their private wealth in case of infringement. A pragmatic solution for this can be a clause such as “The data room is accurate and complete to the best knowledge of common shareholders”, with a small relative penalty (e.g., 20% of an annual salary) at the very best.
- Reporting: Beware of putting comprehensive reporting requirements in the SHA. This clause may cause trouble for years to come. Quarterly reports are ok – but do not further define what this is (at the beginning maybe just a non-accrued CF-statement, enhanced as you grow, will be enough). Some investors may want to see monthly reporting; while providing some monthly KPIs may be something you do, we recommend not to include this in the SHA. Budgets are a similar topic – you may do this, but move to rolling six-month planning or other methods – again, keep it out. Remember: Adding things to what is defined in the SHA is always easy – but reducing is usually close to impossible. Most startup CEOs spend too much time on shareholder reporting, and too little on internal control.
- Negotiation strategy: Some founders explicitly agree with their lawyers to play “good cop bad cop”. With the lawyer being the bad cop – after all it is you who needs to get along with the investors in the future, not the lawyer. While this can work to get some clauses through, experienced investors will quickly see through the plot. So while being tough about certain clauses makes a lot of sense, we recommend not to play any games in the process.
- What happens if you do not find an agreement? Frankly, this should not happen if both parties are professional and speak constructively. Having said this, there are situations where an (unexpected) point leads to a standstill. If you have enough other investors accepting a clause and/or new investors wanting to participate, you may play hardball. But this is more of a worst-case scenario than a strategy.
- Agree with the investors on acceptable versions of both SPA and SHA.
How should you deal with side letters?
You want every investor to sign exactly the same SPA and SHA. Try to prevent side letters.
But there are cases where an investor asks for specific changes or amendments. Here are two examples:
- A financial institution wants to invest but for compliance reasons needs you to sign a contract specifying that you will not do any business in blacklisted countries such as North Korea. While every investor wants you to comply with relevant rules and regulations, such a specific clause will most likely not be required by other investors.
- A strategic investor wants to invest but asks for a first right of refusal to partner in a specific business area. While this can be attractive, it could also limit your future business (and exit) options. So you will want to be very careful going for such a side letter.
The rule of thumb with side letters is as follows: If a side letter is not disadvantageous for any other investors and if you make it transparent for all current and new shareholders, it should be ok to sign it. Discuss with your lawyer before doing anything and include side letters in the closing folder.
- Make sure all investors participate on exactly the same terms. In case a side letter is needed, follow the rules described.
Finalize due diligence
In some cases (confirmatory) DD has already been finished in the last phase, in others this takes up to the very last moment.
If the lead investor writes a DD report, you may want to share it with all investors. In any case, you should download all the documents in the data room to a data stick and archive 2-3 copies. One should be with the lawyer, one with your startup, and potentially one with the lead investor.
- Archive an "official" copy of your data room at your lawyer's office.
Signing: Keep it all electronic, but be precise and transparent
Unless illegal in the jurisdiction of your legal headquarters, you should go for electronic signing. It is the 21st century – and just like due diligence is done in a virtual data room, investment contracts should be handled electronically.
While there are advanced solutions such as DocuSign, a signed pdf version of the final contracts should be good enough (though as always it should be checked with your lawyer). Make sure that you do not just send around an electronic version of the signature page (e.g., page 16 of the SHA) but an electronically signed version of the entire document, and that you do a solid version control in the footnote of all your legal documents.
Your lawyer should provide an electronic closing binder to each new and all existing shareholders at the end of the fundraising round. This binder should contain all signed documents. Accuracy and full transparency are crucial – any shortcut or mistake can hurt you incredibly in the next financing round or prevent an exit.
- Get signed documents from participating investors.
Efficient management of cap table and ESOP
The static management of your cap table should be relatively simple. It can be done in an Excel spreadsheet as long as you don’t have a large number of shareholders. Make sure both your lawyer and you yourself are taking a thorough look at the cap table; mistakes can be very costly or even lead to severe issues over time (in the worst case prevent an exit).
Handling an ESOP can be more complex, especially if it is a program that is not just created for top management but for a broad number of employees. Make sure you keep the full overview over signed documents, vesting and latest contact addresses (incl. of employees who left the company).
The fact that it is difficult to trade startup shares or options is another potential pain point. Several companies are addressing this and have created secondary markets for tech startups.
Here are a few interesting tools you may want to check out in case these topics interest you:
- Decide whether or not to use a tool to manage your cap table and ESOP.
Get the money into your account
While getting the money into your account should only be a formality at this stage, it obviously is of big symbolic importance: your fundraising was successful!
There are a few technical things you need to be aware of. Some countries require you to do the payment of an equity round via a special bank account – a so-called escrow account. The startup only gets access to the money once the financing round is documented in the country’s commercial registry. Opening such a special bank account can take some time.
Another potential pain point can be KYC and Anti-Money Laundering regulations. Big money transfers may trigger various processes at financial institutions that you have not been made aware of. Talk to your lawyer and/or banker ahead of time to make sure these topics are under control.
- Discuss with your lawyer/banker whether an escrow account is needed.
- Check whether all investments are paid in.
Many founders are bad at celebrating – always thinking five steps ahead and getting themselves deeply involved in new challenges as soon as the fundraising starts working out.
But it is crucial to take a step back and celebrate. Not just for you and your co-founders, but for the entire team. Many of them may have felt nervous throughout the process, probably without even telling you.
Here are a few things to consider:
- Special, but cost-conscious: Having raised a big sum of money means you should be throwing yourself a nice party. The time of buying cheap supermarket beer and eating a pasta dinner is has come to an end… – NOT! Keep that low-cost spirit – now more than ever. We will discuss this topic in detail in the next phase. But while you do want to organize something special – having a few beers at the office would not be enough – it is crucial to keep costs under control to prevent sending out the wrong message.
- Communication: You will want to make a short speech at the event. Describe the ups and downs of the fundraising phase. Maybe you have some funny anecdotes (there typically are many of those). You should mention that the money itself is not really that important – but that it does enable you to reach your vision!
- Outlook: Mention that you are now fine-tuning your strategy and OKRs for the coming 2-3 years. Tell them that they will all be involved in this process, and that you will get back to them over the coming weeks. (Note: We will discuss this in the next phase.)
- Celebrate! And don’t worry if a few team members come in late the next morning …