We talk to startups and investors, you get the value.
Many believe there is no need for legal aid in early stage investments: the lawyer will slow down the process and add unnecessary costs to both the startup and the investor. Vitaly Tvardovskiy, attorney for SBH Law Offices told us whether this is true, and at what stages of the deal and why startups should turn to a lawyer.
We talk to startups and investors, you get the value.
Vitaly Tvardovskiy specializes in providing legal assistance to IT business, as well as on issues related to blockchain and cryptocurrencies, has experience in going on ICO and using crypto assets. Some of the most significant projects Vitaly took part in include creating one of the first crypto-exchanges in Belarus with an investment volume of more than $1.4 million, supporting the investment of a venture capital fund worth more than $3 million, and consulting startups on ICO issues in various jurisdictions.
Indeed, you can make a venture deal without a lawyer. This option even has some advantages:
When using standard investment documents you don’t need to waste time for their approval and legal review;
You can save on costs.
Investors and founders can analyze common investment documents and choose the investment instrument most suitable for the parties.
It is now common to use standard forms of investment documents (including SAFE, KISS), which can be signed with minimal changes and without additional procedures.
At the same time, the purpose of raising investments is not only the speed and low cost of registering them.
One of the main goals of raising investment for founders is getting money under favorable conditions. If you do not pay attention to the due diligence of investment documents, you may find that:
Conditions for the investor may block or worsen the next investment round;
The investor will receive a decisive vote and the right to block issues that are key for business development (which was not provided for by the agreements);
The investor will receive most of the company’s shares under unfavorable conditions.
One of the main goals of raising investment for an investor is to obtain a return on investment. Without legal support, it may turn out that:
Some of the agreements important for the investor are not included in the documents (and do not work), or do not work the way the investor expects them to (this most often concerns cases of conversion of investments into shares);
Documents may provide for a forced exit for the investor under unfavorable conditions;
Investor invests money in a company that does not have intellectual property that is of interest to them (it’s owned by the founders or has been created without being formalized by any documents).
All the examples above are taken from practice. Most of the risks associated with the legal validity of the deal can be removed by involving a lawyer.
The role of a lawyer in a venture deal differs depending on the party they represent: the lawyer can act from the side of a startup or an investor. At the same time, as a rule, even if a lawyer participates only on one side (most often on the side of the investor), their responsibility is to ensure that there are no obviously discriminatory conditions for the other party and to check legal compliance at all stages of the process.
The basic terms of the deal are negotiated from the earliest investment stages. Investors tend to use their own Term sheet for deals where they indicate their conditions based on a preliminary startup estimate. A lawyer can help both an investor and a startup to:
Specify the terms in the legal part;
Agree on conditions (negotiations);
Verify the validity of the conditions (practical implementation of the provisions of Term sheet and their compliance with applicable law).
Startups hire lawyers to work with Term sheet to identify their own risks and check whether everything is in accordance with the actually reached agreements.
If the Term sheet is drawn up on conditions that are obviously unfavorable for a startup, a lawyer can participate in negotiations and help find the most optimal solutions.
Investors, as a rule, involve lawyers for comprehensive support of the deal: in this case, the Term sheet is analyzed for practical implementation, including checking the validity of its provisions under the legislation applicable to the target company. As a result of working with Term sheet, a lawyer can offer the most optimal way to structure the deal and select the necessary investment instruments.
Before registering an investment, a lawyer can help:
Investor with Legal Due Diligence (LDD) as part of the deal;
A startup with Vendor due diligence (VDD) before the deal.
At the early stages, due diligence may be limited to checking corporate matters (legal compliance when establishing a company, documents on previous investments, registration of relations between founders) and intellectual property issues (creation procedure, ownership of rights to key intellectual property objects of the company).
At later stages, due diligence can be carried out on all matters of the company activity, the investor can pay attention to issues that are important for them, such as formalizing relationships with key personnel, terms of deals with clients, terms of the previous round of investment.
Based on the results of due diligence, lawyers prepare a report indicating the identified risks and measures to eliminate them (if possible). Having studied it, the investor can change the Term sheet (if significant risks affecting the cost are identified), and the startup can take measures to eliminate risks to increase its estimates and register investments quicker.
Standard forms of documents are not always suitable for the parties: the implementation of all the provisions of the Term sheet often requires a complex change in the internal documents of the startup, which is quite difficult to do without special knowledge.
Investors usually provide draft documents. A lawyer, speaking from this side, can prepare draft documents, most accurately reflecting the essence of the agreements of the parties. The set of documents may differ depending on the Term sheet, the stage of investment, the country the startup is registered in and the applicable law. The task of a lawyer is to choose the best solution and agree on it with the parties.
In practice, it may become clear already when coordinating the documents that the investor or startups understand the implementation of certain provisions from the Term sheet differently. In this case, the lawyer takes over the negotiation process.
On the part of the startup, they check the documents for compliance with the Term sheet and make sure that the agreements of the parties are reflected in the documents correctly. If necessary, they explain and clarify separate provisions of the prepared documents.
As a result, the parties receive working investment instruments that reflect the essence of the agreements. After the completion of the investment round, the documents can be used for future deals (taking into account the changes made to the Term sheet, based on the characteristics of the startup).
This block of questions, as a rule, includes registering a deal, shares (if applicable), amendments to constituent documents, as well as compliance with the conditions for closing a deal by a startup and / or investor.
By understanding how each of the tools used works, a lawyer can evaluate the practical implementation of an investment deal.