IT CAN take months of pitching before you find the right
investor for your business, but finalising the deal can be tricky.
Corporate Finance attorney Adrian Dommisse of Dommisse
Attorneys shares his tips on how to avoid the pitfalls you may encounter during
Finding an investor can be a difficult and time-consuming
process and once you've found one with the right strategy and values, you may
be tempted to rush through negotiations to access the promised cash injection.
However, there can be serious ramifications if the details
of the deal are not negotiated on level playing fields.
Here are some issues for you to consider:
Ask for a term sheet
A term sheet is simply a summary of the deal in a few
It exposes the bare bones of the
fundamental commercial terms of the investment and because it is so concise,
you are less likely to miss some essential detail, as you tend to do when faced
with pages and pages of legal documents.
The term sheet can be an invaluable document because each
board member or founder can get to grips with it quickly and give input from
their own unique perspective.
Always compare the terms on which different investors would
invest. Don’t be tempted (or persuaded)
to commit to one investor unless they offer a genuinely better deal.
Often an entrepreneur is focused on the
valuation of the company, hoping for a higher valuation and therefore a higher
But don’t forget other important points – there may be a
significant “negative” value such as founder restrictions, share claw backs,
rights of investors to sell (their shares and yours!) and other terms that come
along with a higher valuation.
Determine which terms are binding
Before you put pen to paper on the term sheet, be sure to
understand which parts are binding.
Although the terms of a cash injection will not be binding until set out
in comprehensive documentation, the investor may require you to commit to an
exclusivity period, in terms of which you undertake not to negotiate with
anyone else for a set period.
Always check the fees
Once the investors instruct their attorneys to draft the
investment documents, they will expect those fees to be for your account –
usually deductable from the investment amount when it is advanced to you.
However, what if there is a genuine
disagreement on a fundamental term of the investment? Who pays those fees if
the investment never closes?
Make sure that you hash out all the details prior
to signing and make sure that the legal fees are capped so that they won’t
drain your investment funds.
Determine if there are “arranging costs” involved
“Arranging costs" can be significant. If you are negotiating
directly with the investor, this fee may not apply. You could argue that the investor’s profit
will be from their investment (exit profit or distribution of profit), not from
the company’s balance sheet at the commencement of the relationship.
Having said that, it is not uncommon for
investors to take a fee from the proceeds of the investment. There can be valid
reasons for this, such as where a complex deal requires unique, expert skills
But you should investigate any such term in discussions with the
investor to understand why they would do that rather than invest those funds
with you. Check to see if this is common
practice – again, by comparing deals.
Following the above process will help avoid disappointment and may even avert a failed deal later down the line, at your cost.