Four important legal considerations female founders need to know when seeking investment
With fewer female founders securing investment than men, it’s important to properly prepare before seeking finance. Here are four important legal considerations you need to know.
As a women running my own business, I have seen many ups and down in establishing and scaling my business.
I advise thousands of businesses getting ready to start, scale and seek investment right up until they exit or sell. It is never easy and there are always ups and downs, but the market is vibrant right now; investors are keen to enter the UK market and female founders are seeing more active interest than ever before.
The Alison Rose Review of Female Entrepreneurship, published in March 2019, highlighted that up to £250 billion of new value could be added to the UK economy if women started and scaled up new businesses at the same rate as men
Fundraising for many businesses is vital so being prepared is likewise the key. No more so than for start-up technology companies who burn through a considerable amount of money, especially when pre-revenue. This article examines some of the key legal considerations when trying to raise capital for your business.
1) Look at your options
Over the years we have seen many different businesses turn to equity financing without exploring the different options which may be available. For many it is seen as the easy option, but this is not necessarily the case. With equity financing you are giving away a share in your business and welcoming in a new stakeholder who has legal rights and to whom you owe legal responsibilities.
Founders often neglect to explore other financing options, which can be used simultaneously or as an alternative : such as debt financing ( where you do not give up a share of your business) these can be with high street or commercial lenders which are displaying commercial rates presently or maybe you qualify for grants (essentially free money) as the UK offers many.
Businesses should also consider whether there is R&D relief available which can result in a cash payment based on funds you have spent on R&D. In addition founders should explore whether there is any Covid-19 support available to them or low interest debt options.
Founders should be mindful that equity is not the only possibility and may not be the best fit for their business. We hear often ‘women calculate to the last pound so are meticulous, but they never ask for enough’.
This means banks may like the clear accounts and be more favourable or investors thinking its not a big enough investment for them. It’s a juggling act depending on who the pitch/proposal goes to. Backing up the request is essential, but asking for more than you need for plan B can also been seen as more attractive and understood practice and founders are reminded to push forward.
2) Due diligence on your business
It is important that you look carefully at your business and company from the perspective of any potential investor. As part of any investment process you can expect a degree of due diligence. This often takes the form of legal, financial and commercial due diligence.
The extent and volume of due diligence does depend on the amount being invested. It is however important to try and identify swiftly potential areas of concern. So take a look in the mirror and be prepared with concise, executed documents, answers to their tough questions and don’t forget above all to impress upon them your unique selling features, experience and passion.
Areas of legal due diligence can be summarised as being able to respond and address the following key areas:
- Do you have signed and suitable contracts with all members of staff employed or otherwise. These have suitable confidentiality clauses; protects the businesses intellectual property and holds suitable restrictive covenants?
- Do you have signed contracts or valid terms and conditions with all customers and also your suppliers?
- Do you have an agreement regulating the founders, a shareholders agreement is essential for any business?
- Have all shares been properly allotted and transferred?
- Have you filed everything at Companies House that should have been filed?
- Has someone been promised something from the business, such as shares, which isn’t in writing or reflected at Companies House?
- Is there any dispute or litigation or investigation or any risk of the same?
- Who owns the intellectual property of the business and how can you prove this?
- Have you got any consent or license or regulation you need to sell your product or service?
- Have you got a commercial property? Have you got a commercial lease in place or agreement to use the space?
- Have you considered Data Protection carefully?
- Have you registered and protected your IP?
This is just a taste of the legal questions and documents that could be requested from you, that should be carefully audited ; updated and executed to protect the business
3) Is it the right investor?
So often founders neglects to consider whether the potential investor is a good or suitable fit for the business. We would encourage all founders to carry out their own level of due diligence on any potential investor. By selling shares in your business to someone you are creating legal rights and obligations to that shareholder.
With any business there are the inevitable hard times and difficult conversations. Having a suitable investor who is a good fit for your business makes those conversations a bit easier. It doesn’t dilute your obligation or legal duties not to unfairly prejudice them or act in breach of your fiduciary duties but it may make it a bit easier to address and remedy.
Do they understand your business or products ; could you ask them for assistance to scale or additional monies if necessary; do they have the qualifications, experience or contacts they profess and what do they want from you?
There are many different types of investors and each fit different types and scales of businesses. Depending on the size and stage of the business this may be venture capital, private equity, angel investors, trade investors or friends and family.
Some of the due diligence you should be doing on any potential investor and questions you should be asking are:
- What are the investors exit plans? Are they aligned to yours?
- What is their and your expectations of a return?
- What other companies are in the investor’s portfolio
- What is the length of the fund?
- What is the impact or sector of the fund?
- How involved does the investor want to be?
- How experienced if the investor?
- Do they benefit from EIS have you considered this?
- What demands are they making?
4) Legal documents
The documents you can expect to receive as part of an investment round is:
- A subscription agreement or investment agreement. This regulates the terms upon which the investor is putting the funds into your business. This is likely to include warranties or promises about the business and your company so these need to be carefully scrutinized;
- A shareholders agreement. This regulates the high level operations and running of the business. It governs the relationship between the shareholders. This document typically includes ‘reserved activities’ or ‘investor consents’ which are the list of activities that the company can and cannot do without the consent of the investor. This is where you negotiate
- A disclosure letter. This deals with specific disclosures against any warranties so you declare anything required so its not later held against the company, as it was on the table.
You may also receive updated service agreements (employment contracts) for the founders governing their role in the business and usually include provisions on payment and expectations on services.
The legal documents for an investment round can be intimidating, these are usually lengthy and typically contain complex terminology. What is vital, however, for any founder is to ensure that the documents work for them and fit their business. The agreements are worthless if they are unrealistic for the business.
A founder should familiarise themselves with each and every clause and be confident that they understand exactly what they are agreeing and the impact on them and the business.
Often, we are confronted by Investors, or their representatives trying to negotiate a provision as ‘standard’. Never forget that this is your business and you can always attempt to negotiate any and all terms and restrictions. Sometimes you never know the investor may be hiding behind something being ‘standard’ because they don’t know themselves what the clause is saying or the impact of the same.
It is often daunting to go through an investment round, there is new and complex terminology and it usually a stressful period as ultimately your business needs the funding to be able to continue. We understand this and work closely with founders taking on investment to ensure that they fully understand what they are agreeing and the impact on them and their business.
Why is there still such a difference in investment afforded to male owned businesses to those founded by all women?
Analysis of this data reveals that women-led businesses are as likely as male-led businesses to receive the finance, so its not the unwillingness of VC’s to invest, but more a lower number of applications and pitches made or for a lower value.
UK VC & Female Founders report, commissioned by Chancellor Philip Hammond at Budget 2017 and undertaken by the British Business Bank in partnership found:
- For every £1 of venture capital (VC) investment in the UK, all-female founder teams get less than 1p, all-male founder teams get 89p, and mixed-gender teams 10p.
- Venture capital investment in start-ups with female founders is increasing but progress is very slow. At current rates, for all-female teams to reach even 10% of all deals will take more than 25 years (until 2045).
- 83% of deals that UK VCs made last year had no women at all on the founding teams.
You would hope things have changed, but data showed in 2020 of the £12 billion of UK VC investment invested, companies with an all-female founder team would have received just £120.1 million. Mixed-gender teams would have seen £1.2 billion and all-male counterparts, just shy of £10.7 billion.
This again though we fear is more about applications rather than decisions. A report on acceptance / rejection would be interesting but not easily put into context. Essentially, the number of female founders securing investment is increasing but is still far apart from that taken up by all male founder businesses. And we need to question why are there are fewer female founders seeking investment.
Are there fewer female founders in general? Do they prefer to self-fund and consider debt financing? Or are they being rejected? Whatever the reason we need to encourage and support all businesses to scale up and become successful and particularly entice female founders into the investment ring.
A City Law Firm offers a range of commercial and life services that benefit both sexes.
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