[Insert Investor Name] has agreed to provide a loan (“the Loan”) to [Insert Company Name] in accordance with the loan agreement which is dated the same date as this agreement (“the Loan Agreement”).
The parties have agreed that if (but only if) the Loan is not repaid in full on the repayment date set out in the Loan Agreement, then the will be converted into shares in [Insert Company Name] in accordance with this agreement (this event is called “the Conversion” in this agreement).
In this agreement:
[Insert Company Name] is called “Company”;
[Insert Names of Founders] are called “The Founders”;
[Insert Investor Name] is called “the Investor”; and the Loan (if there is a Conversion) is called the “Investment”.
This agreement also gives the Investor rights of consultation over some of the Company’s actions to help the Investor to safeguard its/his investment.(B)
The Founders of the Company agree to co-operate with the Investor and to run the Company as agreed, should the Conversion take place.
The Founders also make a series of statements (called warranties) about various aspects of the Company as at the date of this agreement, and acknowledges that the Investor has relied on the truth of those statements when agreeing to make its/his investment.
[Insert name of company]
[Insert registered office address line 1]
[Insert registered office address line 2]
[Insert name of company]
[Insert registered office address line 1]
[Insert registered office address line 2]
- 2.1 If there is a Conversion, the Investor will acquire the number of shares in the Company set out in Part 1 of the Schedule in return for the Loan and the Company agrees to issue these shares to the Investor. These shares are of a certain type or “class” which is specified in Part 1 of the Schedule and the rights and responsibilities which go with those shares are described in the Company’s articles of association.
- 2.2 The Founders give up any rights that they may have to buy some or all of these shares before anyone else so that the shares may be issued to the Investor – called “pre-emption rights” (but do not give them up for any other purpose).
- 2.3 Following the date of this agreement the Company will hold a board meeting at which it will approve a resolution approving the allocation of shares in the event of a Conversion. The Founders will vote in favour of that resolution.
- 2.4 In the event of a Conversion, completion of the share acquisition will take place within seven days of the non repayment of the Loan or the Event of Default under the Loan Agreement which triggers the Conversion.
- 2.4.1 On the date of completion the Company will hold a board meeting authorising the allocation of shares to the Investor by way of Conversion of the Loan, and the Founders will vote in favour of that resolution.
- 2.4.2 The Company will issue a share certificate to the Investor for the number of shares set out in Part 1 of the Schedule and enter the name of the Investor in the Company’s share register.
- 2.5. Schedule 2 sets out the share structure of the Company as at the date of this agreement
Also included in this document:
5. Business Plan Information
6. Things Requiring Consultation
7. Share Transfers
8. Restrictions on Founders' Activities
9. Confidentiality and Announcements
Tip Sheet for Funding Agreements
When you negotiate for investment at an early stage, it is normal for a "term sheet" to be negotiated with the investors. The conditions you agree to now will influence the whole life story of the company, so it's useful to get advice at this stage covering issues like shareholder controls going forward.
Any investor or buyer will want to perform diligence before completing the transaction. This means that they will want to look at key financial records and accounts, existing contracts with customers, suppliers and employees, and corporate records. The better and more complete your documentation is, the more inclined they will be to agree with your valuation.
When you offer shares to investors or purchasers you may be making what the law calls "a financial promotion". There are complicated rules about what you can and cannot do. If you don't follow these rules you could end up with the transaction being set aside - or worse still you could face criminal penalties. This is one area where it pays to take advice.
Whenever you take in investment your control over the company will decrease. It's important to think this through at the time and look carefully at any proposed restrictions. For example do they restrict you from raising further money? Or entering into particular types of contract? Or changing the business? Are these controls customary for this kind of transaction? It's worth checking...
Share Holder Rights and Dilution
Investors will often ask for favoured or preferential treatment when it comes to looking at a sale of the company, paying dividends or liquidating the company. They may also try to make sure that their share ownership is not diluted in the event of subsequent investment. You need to carefully consider these provisions when they come up, as agreeing to them may put off other investors who come in during later rounds of investment.
Providing Accurate Warranties
You will be asked to make all sorts of promises or “warranties” in any funding document. It may be tempting to take a “seat of the pants” attitude to these promises, but you could open yourself up to criminal or civil legal action if you make statements which are misleading or not accurate. So, it’s worth making sure that anything you say in the funding agreement can be backed up with financial or documentary evidence.
This is the most important moment for any SME. You want to be able to control it – but larger investors may try to say that they have the right to force or block a planned exit. Are you happy with this? Equally you need to be able to make other minority shareholders sell if you are sure that the exit moment has arrived. These are critical provisions to address in a funding agreement.
What Happens if you Leave?
Investors may well require provisions for the management team, which mean that if they leave the Company, they have to give up all their shares or sell them at a reduced value – particularly if they leave under a cloud. So, these provisions require careful scrutiny – you don’t want the value you have worked so hard to create to be taken away from you.
LawBite Legal Advice
LawBite professional advisors can help you straightaway with all of these issues and more. Just go to the the Legal Advice section and make your enquiry. We’ll get back to you within 24hrs with a meaningful response.
Clive Rich is a highly experienced entertainment and digital media lawyer, who has also successfully run digital businesses for companies such as Sony and Bertelsmann.
A qualified barrister, he has been a lawyer for almost 30 years and has drafted and crafted contracts for a broad spectrum of multi-nationals, major organisations and brands, including Yahoo, Apple, Napster, SanDisk, Myspace and the BBC.
He has also previously run his own legal practice, Rich Futures Ltd in association with the Top 30 UK law firm, Olswang LLP, representing a variety of technology companies and SMEs.
Clive is a qualified Mediator through the Centre for Effective Dispute Resolution (CEDR) and a qualified Arbitrator through the Central Institute of Arbitration (CIArb) in London.
As a negotiator, he is the author of “The Yes Book: the Art of Better Negotiation”, published by Random House in March 2013. Clive has also designed and successfully launched a negotiation App called “Close My Deal”, enabling people to understand the basis of successful negotiation and apply the skills to everyday scenarios. He has provided negotiating coaching and deal making services to a wide range of large organisations and SMEs. He has also been a board member of a number of digital SMEs.
Clive is a devoted father and husband, but when he is not spending time with his family, he likes to unwind by playing golf or watching a variety of sports (football, rugby, cricket). He's a lifelong Milwall FC fan... but don't hold that against him!
Step By Step Guide
1. This identifies the parties to the agreement. Here we have two companies identified by company number as well as name and registered address. This can be changed to individuals if you are not a registered company but remember to include full names and addresses.
2. The overview. Here we have a narrative of the background and the purpose of the agreement being that the money will be lent subject to a number of terms. Here if the loan is repaid by a certain date then it will be “converted” into shares in the borrowing company. Effectively then the “conversion” becomes an investment and the lending company becomes an investor. There are certain ways the investor can protect their investment and on conversion the agreement allows them a number of rights over the borrowing company or “founders” as they have become shareholders.
3. In return for making the loan, the lending company may acquire shares in the borrowing company if the loan is not paid back by the date set down in the schedule. The number and type of shares are laid out in the schedule. The borrowing company will transfer these shares and cannot claim what are called “pre-emption” rights which could previously have been attached to them. This means that in the first instance the new shares may have been offered to existing shareholders of the borrowing company and would have been transferred there before anywhere else. On the signing of this agreement this right is cancelled.
4. There follows the procedure to be followed on the transfer of shares including the board meetings and board resolutions that follow any share transfer and the agreement that the borrowing company will pass any such resolutions by voting in their favour.
5. In the event that the “Conversion” goes ahead and “triggers” the share transfer, it will take place within 7 days of non-payment of the loan and the share certificate will be issued.
6. Warranties and what are they? These are guarantees or promises about the company and as an investor they will provide you with assurances about certain facts and conditions surrounding the company. The warranties are laid down at Part 3 of the Schedule. So here the founders of the borrowing company are giving you assurances about the assets of the company, its financial records, structures and agreements etc. Basically the mechanics of the company are listed. Why does this affect you as an investor and now shareholder? If any of the warranties prove to be inconsistent with what is listed in the contract there is action you can take. At the end of the day you have potentially chosen to invest in a sound and viable company based on these warranties so if they are incorrect or have been misrepresented you can rely on this contract to pursue legal recourse which takes us to clause 4 (“Limitations”)
7. So further down the line you do find a problem with one of the warranties. You must present details of this in writing within 2 different time frames depending on the warranty. If it relates to a tax warranty you have 7 years to provide written notice to the company whereas with the other warranties you are time barred to 2 years so watch the clock! The company’s liability to you for such a claim is limited here to the total value of the loan you made together with your reasonable costs of bringing such a claim. So in any case you will only retrieve the money you put in at the start. In addition the money you claim must exceed the figure detailed at Part 1 of the Schedule so please consider this figure carefully.
8. Business Plan – Why is this here? Where the loan becomes converted to shares the company and its founders are under a duty to produce a business plan and a budget. At the end of the day cash has been injected into this company so this needs planning and consideration and in turn the information needs to be piped to the investor.
9. This agreement places certain restrictions on the founders (existing shareholders) and an assurance that each one is on a “service contract” which is an employment contract where they are employed or a similar contract where they are a director.
10. We end with the general provisions that appear in most legal agreements. The contract and what it entails is obviously confidential and other standard clauses with a signing clause to finish. There is also an option to “e-sign” where applicable for you to consider. With the particular arrangement here there is also a clause confirming the investor falls within the definition of a “high net worth” individual which satisfies a piece of legislation called the Financial Services Act 2000.
When To Use this document:
Where you lend money to a company it can be a good idea to agree that the loan is converted into shares on the happening of a certain event. It can almost be used as a form of “bridging finance”. So you lend money to the company as a way of raising capital for them or to fund a large commercial agreement and after a passage of time (say when the large commercial agreement has been signed and is in full throttle) you convert the loan into shares. The Convertible Loan Agreement contains terms governing the timing and manner of such events and can be tailored as always to the specifics of the transaction.