Early-stage investments
What do the new BVCA model documents mean for early stage companies and investors?
Context
If you're a company or investor involved in early-stage investment, chances are that sooner rather than later you will be negotiating a fundraising round based on model documents produced by the British Private Equity and Venture Capital Association (BVCA).
The BVCA model documents are, strictly speaking, aimed at Series A fundraisings, but are widely used for other transactions in the market since they provide a useful 'benchmark' position on many issues.
Having not updated its suite of documents since 2017, the BVCA published a revised suite earlier this year.
Notably, some of the changes reflect a drive to align with equivalent model documents used in the US.
In this feature, we look at the changes most relevant to those negotiating heads of terms, since the revised suite does not (as yet) include an updated model term sheet (equivalent to heads of terms).
We will provide a further update with our comments on the updated model term sheet (and management rights letter, which is also yet to be released) once those have been released by the BVCA.
Founder-friendly change
Founder warranties: no longer the default
A notable change in the newly revised subscription agreement (now an individual standalone document separated from the model shareholders agreement) is that founders are no longer required to give any warranties in their personal capacity.
Now, only the company itself gives warranties (on numerous subjects such as the company accounts, taxation, intellectual property, litigation etc.) on the justification that companies raising Series A funding are likely to be sophisticated enough to stand behind any warranties provided.
This is obviously a welcome development for founders, as previously founders would be personally liable to investors for breach of warranty under this arrangement (albeit subject to a liability cap usually set at a multiple of salary).
It's worth noting that if a warranty is qualified such that it is subject to the company’s awareness, it is likely that such awareness will be negotiated to include the actual and implied knowledge of the founders.
Investor-friendly change
Loss of all shares for founders who breach non-compete restrictions
Under the model articles of association, even if a founder initially leaves as a "Good Leaver", they can subsequently turn into a "Bad Leaver" (and, in effect, lose all their shares for virtually nil value) if they commit a "material breach" of any non-compete obligations in either the shareholders' agreement or their employment contract.
Whilst there are UK Government proposals to limit the length of non-compete restrictions in employment contracts to 3 months (see our update here), no such statutory restrictions will apply to any restrictions in shareholders' agreements.
Therefore, founders should pay particular attention to any non-compete provisions applicable to them and limit so far as possible.
Finally, it’s worth noting that the starting position under the revised model articles of association is that even a Good Leaver’s unvested shares will be converted to deferred shares with an aggregate value of a penny.
Investor-friendly change
Disclosure letter
The updated subscription agreement now contains a pro forma disclosure letter relating to the investment.
The role of the disclosure letter is to put the investor on notice of matters which are relevant to the warranties given by the company (therefore meaning that a breach of warranty claim cannot be founded on matters disclosed).
Notably, the standard position in the disclosure letter is that company documents disclosed in the data room (e.g. key contracts) or other documents provided during due diligence are not deemed "disclosed" under the disclosure letter. Therefore, simply including documents in the data room will not be sufficient to prevent a breach of warranty claim.
Investee companies subject to oversubscribed investment rounds may leverage their position to reverse the starting position that documents provided in a data room are not deemed disclosed.
However, if this standard position is accepted, the company should ensure that key documents (and any matters covered in the documents relevant to the warranties more generally) are expressly referenced in the disclosure letter itself.
Company-friendly change
Pre-emption rights
Pre-emption rights, generally speaking, give existing shareholders rights of first refusal on any new fundraisings. The new BVCA articles of association provide for more company-friendly pre-emption rights than previously in order to "make it easier for companies to raise financing from outside investors".
Specifically, the BVCA articles of association provide:
- that pre-emption rights can be disapplied by 'Investor Majority Consent' (i.e. the holders of an agreed % of shares) rather than the previous (higher) threshold of 75% of voting shareholders.
- recourse to prevent a situation where the Investor Majority disapplies pre-emption rights and then some of those same investors participate in the relevant fundraising round (thereby meaning other investors miss out on the opportunity to participate), the waiver would be disapplied/void in those circumstances. The other investors would then have pre-emption rights engaged.
- an option to limit pre-emptive rights to only 'Major' investors, not all investors, at a % shareholding to be agreed. This is intended to reflect the reality that new capital raises are largely driven by the board and the company’s significant investors.
"The deployment of US capital into European sports and sports tech assets has been a defining feature of the past two decades.
By aligning the BVCA model documents more closely with its US equivalents (NVCA), it better aligns expectations on deals with an element of US funding."
Kingsley Boateng - Associate, Northridge
