In Part VII of this series, we explored the nuances of negotiating the executive employment agreement (EEA). In this part, we revisit the share subscription agreement (SSA) but with a sharper focus on specific negotiation points and practical strategies for founders to align expectations with investors. These often-overlooked pointers are critical for ensuring a balanced relationship, safeguarding both the startup’s operational needs and investor interests.
As previously discussed – the SSA is an important document in venture capital investments. It sets out the terms for share subscription, pre-investment obligations, and the rights and responsibilities of the parties involved. While the document primarily seeks to protect the investors’ interests, founders must approach the SSA with foresight to ensure that these protections do not pose overtly onerous obligations on the business or founders in their personal capacity. Thoughtful negotiation can prevent potential conflicts and align long-term goals.
Key Considerations for Balancing Expectations
In this article, we explore two key aspects that require thoughtful negotiation: harmonizing expectations among lead investors and streamlining conditions precedent to ensure efficiency.
1. Harmonizing expectations of multiple lead or major investors
When a funding round involves two or more lead or major investors, their priorities can diverge, leading to friction over critical aspects such as control, timelines and governance. Balancing these expectations is crucial to avoid delays in the funding process and to maintain operational stability. The key challenge is that each institutional investor prefers influence over decision-making, particularly regarding the fulfilment of conditions precedent (CPs), the timing of fund disbursement, or governance rights post-closing. Without a unified approach, the founders risk being caught between conflicting investor demands, leading to unnecessary delays and inefficiencies in execution.
To mitigate these conflicts, founders can propose a lead investor clause in the SSA to designate one investor as the primary coordinator. This investor would act as the main point of contact for approving CPs, aligning timelines for fund releases, facilitating the closing process and other procedural aspects involved with concluding the investment round. By streamlining decision-making, this approach ensures that founders do not have to navigate multiple conflicting instructions, thereby expediting the funding process and enhancing operational clarity.
Deadlocks can arise when multiple lead investors have equal control over critical decisions. Adopting a majority approval system for approval and extensions to CP timelines would ensure that decision-making remains efficient. This prevents individual investors from stalling progress by withholding approvals and maintains momentum in the funding process. Another option is for the lead investor to anchor the closing date decision and if other investors have concerns regarding completion of condition precedents, they can opt out of the investment. The latter is just a documented option and rarely occurs in actual practice.
Implementing these strategies will foster a more efficient and collaborative investment environment, ultimately benefiting both investors and the company’s long-term growth. It also allows all parties to agree on the transaction documents to expedite the funding process for the business.
2. Conditions precedent – keeping them focused and efficient
CPs are the set of obligations that the startup and its founders must fulfil before the investors release their funding. While CPs are essential for addressing compliance and regulatory gaps, an overly expansive or ambiguous list can delay closing, strain founder resources and divert founder focus from core business activities. The key problem with broad conditions precedent is that investors often include CPs that go beyond statutory requirements, such as subjective operational improvements or minor compliance corrections. These non-essential CPs can create bottlenecks in the funding process, delaying capital infusion and increasing the administrative burden on founders. Some strategies to deal with such issues are discussed below.
Limiting the scope of CPs to critical regulatory and statutory obligations is essential for the deal. This could perhaps include some time-consuming actions such as filing statutory forms for share allotment, obtaining necessary tax registrations (e.g., GST), or securing industry-specific operational licenses or permits. By focusing on these vital requirements, founders can avoid delays from non-essential tasks, ensuring legal compliance and smooth deal closure without unnecessary administrative hurdles. To streamline the closing process, non-essential compliance tasks and low-risk issues identified during an investor diligence can be deferred to the post-closing phase. For example, instead of “obtaining a regulatory approval” founders could negotiate to “initiate the application process” pre-closing, with completion deferred to post-closing.
Similarly, founders can seek partial waivers for CPs that are not material to the transaction (even post signing). Investors may agree to waive certain conditions if they do not significantly impact the deal’s outcomes at that stage. However, such circumstances rarely occur. These waivers help to prevent unnecessary delays due to non-critical requirements.
Lastly, investors typically provide a detailed list of CPs during the middle of SSA and SHA negotiations – often following initial due diligence. To maintain momentum, founders should proactively initiate CP-related work as soon as potential requirements are identified. For instance, applying for essential licenses or preparing draft employment agreements and seeking preliminary approval from the lead investor can expedite the process. By anticipating CP obligations, founders can reduce bottlenecks early on.
In summary, founders should aim for a focused and efficient CP list to ensure that critical funding milestones are not delayed by ancillary tasks. By prioritizing only necessary CPs, such as financial or operational readiness and deferring minor approvals or filings to post-closing, they can keep the deal on track and secure funding more efficiently. This approach reduces unnecessary delays and ensures that key milestones are met without getting caught up in secondary tasks.
Conclusion
Balancing expectations under the SSA is about aligning the priorities of investors with the operational realities of the startup. Introducing a lead investor clause can simplify interactions with multiple investors, while streamlining CPs ensures timely funding without unnecessary delays.
With this article, we have highlighted two critical aspects of SSA negotiations. In our next article, we will delve deeper into other important points such as representations and warranties, indemnities, and specific indemnity rights.
Pooja Agarwal | Senior Associate; Ajay Joseph | Partner
Views expressed above are for information purposes only and should not be considered as formal legal opinion or advice on any subject matter therein.