What are the legal issues I should watch for when selling a stake in my start-up business?
Friday, June 10, 2011/
The main thing to remember is you will need to get clarity on a number of key items. This could mean having open discussions with the investor and then documenting your arrangements in at least a detailed binding term-sheet, or preferably a shareholders agreement. The more specific you are on these items from the outset, the lesser the risk of an argument later.
From my experience the key items to agree and document are:
1. Structure and ownership
One thing to check at this point is whether or not your current business structure allows an investor to take a stake in your business. If it does not, such as if you operated as a sole proprietor, then you may need to convert your structure into a company to enable you to issue shares to the investor to represent its ownership stake in the business.
You will need to consider and document how much of the business you are going to part with and for how much. If you are issuing shares in a company, you may need to consider the Corporations Act to ensure you are complying with the fundraising rules. You should also consider getting any offer documentation or information memorandum checked to reduce the risks of liability for misleading or deceptive statements.
Many investors may not want absolute control over the management of your business. However, they will usually require a seat at the board and/or some degree of control over the strategic direction of the business and certain material business decisions. They may also want certain protective covenants so that they can step in if the business is doing poorly to protect their investment. If such measures are put in place, they should be clearly documented and you should be comfortable with the level of control you are giving to the investor.
Some investors may simply provide finance by buying their stake in your business. Others may provide additional financing through debt, preference shares, or even convertible notes that allow them to convert their debt into equity at their election. You should also clearly document if and how investors may provide further financing, and what happens if your business does not perform as expected.
4. End game
The investor may be investing in your business with a particular objective or outcome in mind. For example, the investor may expect that your business will be sold in a few years to realise their investment. Accordingly, you should discuss with your investor their intended outcome so that all parties are working towards the same objective. You should also check whether there are any rights the investor may have to “force” a particular outcome.
In summary, you should work out as much of the specifics as you can with the investor and then clearly document them. Also, never be afraid to ask for help. All the best!