22 March, 2022 - 16:48

Is your company investment ready?

It is important for early stage companies looking for equity investment from business angels or venture capital funds, to ensure that they are as ready for investment as they can be, writes Quentin Golder, Corporate Finance Partner, Birketts LLP

Any seasoned investor is almost certainly going to carry out some due diligence on the investee company, so it is important to minimise the impact of anything that might give cause for concern. 

While there will be fundamental issues that an investor will need to be comfortable with, for example the available market, the quality of the investee company’s products or services, and the experience of its management team, there will be certain other matters that investors will expect the investee company to have in hand. 

A failure to do so will not only slow down the investment process, but potentially also raise doubts about other aspects of the company’s business. Some areas where issues frequently arise in connection with early stage companies are:-

Ownership of IP created outside of the company

If you have engaged consultants, friends or colleagues to help create IP utilised by the company, have they assigned their rights in that IP to the company? 

Many people think because they have paid a third party (not being an employee) to perform services for their company that the company automatically owns any IP developed in the course of those services. 

That is not necessarily the case. In terms of copyright (which would, for example, cover software written for the company), in the absence of any express contract dealing with IP ownership, such ownership rests with the author. The company may have an express or implied licence to use any such software.

Ownership of IP created prior to incorporation

Many founders create or acquire IP prior to actually forming their company or commencing trading. That is not at all surprising, given it is usually the idea behind the company that comes first. 

However many founders seem to think that because they subsequently form a company which they own and control, to commercialise their IP, that somehow the company will automatically own that IP. That is not the case. 

Investors will want to see that all IP created by founders relating to the business of the company is formally transferred to that company. The difficulty is that often people who might have been initially involved with the creation of such underlying IP may no longer work with the company. 

That can result in having to track down such persons and trying to get them to sign up to IP assignments, long after they have any active interest. That can sometimes create difficulties where such persons seek to use their leverage to seek additional benefit. 

Open source licences

Many start-ups (and indeed more mature companies) utilise open source software to develop products and services. In many cases that poses no problem, but some open source licences contain provisions requiring the users of the open source licences to (among other things) make any products created from the use of such open source licences, available for public use. 

Not surprisingly, that can be problematic. Most venture funds require specific warranties in their investment agreements covering the risks presented by the use of open source software licences. 

Again, before utilising any open source licence, you should carefully check its terms to see what the ramifications of its use may be. Where any open source product has been utilised, be ready to address the issue with your investors. 

Plans for providing actual shares in the company (as opposed to options) to employees, advisers, directors, friends, family 

It is not uncommon for founders to have plans to reward people who have made meaningful contributions to their company with equity in that company.

Often, impending third party investment crystallises such plans. The issue is that it is probably going to be more tax efficient for any such issues or transfers of shares to occur prior to any third party investment being made. 

An arm’s length investment is going to create a market price for the company’s shares. Any attempt to transfer shares at or following a funding round at a price less than that used in the round, particularly to anyone who is an employee or director, is likely to create adverse tax consequences for both the recipient and the company itself. 

Hence, if you envisage any ‘friendly’ issues or transfers of shares being made, it is almost certainly better for them to be made prior to any third party investment, with as big a gap as possible between the date they are made and the date your funding round occurs. 

Failure to do so might make any subsequent transfers or issues to such persons not financially viable.

Company books, records, and Companies House filings

While many companies are not always on top of their statutory obligations with regard to records and filings, the absence of records and inability to stay on top of statutory filing obligations is not a good look from an investor’s perspective. 

If a company cannot manage its relatively basic obligations in that regard, is it on top of its other record keeping and management obligations? It’s also another matter that will take additional time and effort to bring up to date, when investors will be wanting founders focused on driving the business forward, not correcting past mistakes. 

Time spent making your company investment ready is time well spent. Matters such as those set out above will not get any easier to fix as time passes. If left alone they can become even more problematic.

You can email Quentin at:  Quentin-golder [at] birketts.co.uk or call him at the Cambridge office on 01223 326586.

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