Jargon busting the series A investment documents

Friday 25th March, 2022

To help founders and start-ups demystify some of the terms used in series A investment documents, Graham Halliday has put together a summary of a selection of terms used.

Liquidation preference

When a company is sold or liquidated, investors will usually look to recoup their investment in priority to the company’s ordinary shareholders by relying on a liquidation preference in the company’s articles of association. The preference is usually only triggered when a company is sold at a valuation lower than the valuation an investor originally based its investment on. Where the company is sold at a higher valuation, it usually makes sense for the investor to participate in the sale proceeds proportionally with the other shareholders instead of triggering the liquidation preference.

Anti-dilution rights

Anti-dilution rights enable an investor to limit a potential decrease in the value of its investment in the event its investee company later raises funds at a lower valuation than the valuation the investor originally based its investment on. These rights are typically included in the company’s articles of association and usually give the investor the right to be issued additional shares to compensate it for the reduction in the value of its shareholding.

Co-sale rights

Founders and employees may look to sell some of their shares prior to an exit event to realise some of their equity in the company in the interim period. If they find a buyer, investors may also want the opportunity to sell some of their shares. Co-sale rights give investors the right to sell a proportionate number of shares to the same buyer.

Disclosed

Under the series A investment agreement, the investee company and its founders will usually be asked to give contractual statements about the company’s business, known as warranties. To avoid a claim for a breach of warranty, the company and its founders will often make disclosures if warranties cannot be given or need qualification. Whether there has been a valid disclosure will depend on the definition of disclosed, but it will generally need to be fair, accurate and allow the investor to understand the scope of the disclosure.

Leaver

When a founder or employee shareholder ceases to be an employee or consultant of an investee company, investors will usually want provisions in the company’s articles dealing with the departing employee’s shares. These shareholders are typically known as leavers and may be required to give up some or all of their shares depending on the circumstances of their departure and how long they have been with the company.

Amend and restate

If a company has already put in place a shareholders’ agreement prior to the series A round, the company can update the shareholders’ agreement by amending its terms to reflect the series A round, instead of terminating and replacing the existing agreement. This is what is known as amending and restating the shareholders’ agreement and is often easier to do than terminating and replacing the existing agreement, as you usually only need a certain threshold of shareholders to amend the agreement, while all shareholders are typically required to sign-up to a new agreement.

CFIUS

The Committee on Foreign Investment in the United States (“CFIUS”) has authority to review, approve, restructure, block or unwind transactions that result in foreign control of a US business and implicate national security concerns in the US.  Over the years, “national security concern” has been interpreted broadly, and has even included certain real estate transactions and collection of certain data.  If your company has US operations, we advise that you consider the implications of CFIUS before raising investment.

Articles by Graham Halliday