NCFAs innovation and funding ecosystem

Top 5 legal considerations every tech entrepreneur should know

Gowling WLG | Tara Amiri-Khaledi | Nov 24, 2020

Entrepreneurs and startups - Top 5 legal considerations every tech entrepreneur should know

As an entrepreneur trying to get your business off the ground, there are many factors to think about and the legal "stuff" may easily be forgotten. In this article, we touch on the top 5 considerations entrepreneurs need to think about when starting out.

Term Sheets

Once you have structured your business, you will have your idea tested (hopefully) and you will need capital. One typical way is to look for parties that will invest in start-ups such as angel or venture capital investors ("VC"). At this point, you will hear the term "Term Sheet" a lot.

See: 

Debt vs. Equity Financing: Pros And Cons For Entrepreneurs

7 Types of Investors to Avoid Like The Plague When Trying To Raise Capital For Your Startup

Convertible Debt vs. Equity: Which Is Right for Your Startup?

At its simplest form a term sheet is a summary big picture document of key terms agreed upon between the entrepreneur and the VC in contemplation of a financing and will cover, at a minimum, "economics issues" (valuation of the company, i.e. how much money for what percentage of the company) and "control issues" (who will run the company). The term sheet is an important document, as it signals that the VC is serious about an investment and will serve as a roadmap for the relationship between the parties.

Provisions included in a term sheet are typically non-binding and at least subject to due diligence, other than confidentiality and exclusivity provisions which require the parties to keep the information disclosed VC between them confidential and only negotiate with each other  for a specified agreed upon period of time (typically 30-60 days), which are usually binding on the parties.

Shareholders Agreements

Following the execution of a non-binding term sheet, the VC will typically work with the entrepreneur to complete its due diligence and prepare definitive legal documents, which typically includes a shareholders agreement.

See:   Why Partnerships Are the Future for Fintech

A shareholders agreement is a contract between all of the shareholders of a company and the company itself. It attempts to: (i) structure the relationship between the shareholders of a company, (ii) create certainty and set the expectations between the parties, and (iii) anticipate and address many of the potential future disputes. A shareholders agreement can also be an effective way to set out the details of how a business will be run. It is important to think about the business and the shareholders and their specific needs when drafting this document and anticipate what is needed in each case. This document, while containing certain typical provisions, can be tailored to the specific needs of each group (i.e. there is no "simple standard shareholders agreement).

Rights that VC or major investors look for when investing in a business

So what are these rights that are negotiated in a term sheet and then ironed out in a shareholders agreement?

Other than terms relating to economics (valuation of the company) and control (who will make decisions and run the company), the following are some of the rights VC and major investors look for when investing in a new company:

Liquidation preference - preference in getting paid out first in the event of liquidation of the company;

Participation rights - right to participate in future financings to maintain percentage ownership;

Veto rights  - right to prohibit certain material or significant changes for the company;

Anti-dilution rights - protection against the company issuing shares at a valuation lower than the valuation represented by the VC investment;

Vesting - a VC will want to make sure that the founders are motivated to stay and grow the company, as a result, they will likely request that shares owned by the founders become subject to vesting based on continued employment (and then become "earned") over a period of time. Typical vesting for founders is monthly vesting over a 36 to 48-month period, with the first 12 months of vesting delayed until 12 months of service are completed. A form of vesting that is usually acceptable to VCs is the so-called "double trigger" acceleration vesting, where vesting accelerates and shares are considered "earned" if the company is acquired and if the buyer terminates the founder's employment without cause after such acquisition;

See: 

Top Investors Advice To Prepare For The Next Decade

Retail investors are becoming more than shareholders

Drag along and tag along - a drag-along provision is a clause that allows majority shareholders to force the minority shareholders to join in on a sale of their shares. This prevents small shareholders from creating a roadblock to an acquisition by objecting or exercising appraisal or dissenters rights under applicable law. Tag-along rights on the other hand allow minority shareholders to sell their stakes in a company if a majority shareholder wishes to sell its stake in a company. Tag-along rights are usually good for minority shareholders because they allow the shareholders to capitalize on a deal that another shareholder is able to strike. These clauses (tag-along and drag-along) balance each other out and are typically either both included or left out of a shareholders agreement; and

Information rights - right to obtain certain information such as financial information.

Continue to the full article --> here

 


NCFA Jan 2018 resize - Top 5 legal considerations every tech entrepreneur should know The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org

Latest news - Top 5 legal considerations every tech entrepreneur should knowFF Logo 400 v3 - Top 5 legal considerations every tech entrepreneur should knowcommunity social impact - Top 5 legal considerations every tech entrepreneur should know

Support NCFA by Following us on Twitter!






NCFA Sign up for our newsletter - Top 5 legal considerations every tech entrepreneur should know



For more information about FFCON21: BREAKING BARRIERS, on-demand videos and ways to participate




 

Leave a Reply

Your email address will not be published. Required fields are marked *