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How to Prepare a Company for Investor Engagement: Key Steps to Success.

The involvement of an investor can significantly influence the company. It is essential to establish contracts, governance structures, and rights protection effectively. The term sheet and Shareholders' Agreement (SHA) are instrumental in mitigating potential future disputes.

The entry of a new investor into a company can significantly impact its current operations. How can you ensure that the entry process proceeds smoothly, does not disrupt the functioning of your company, and does not lead to any future issues? This article aims to provide insights into these questions.

Take your time

It is crucial not to rush the entire process, to focus on the management and control mechanisms of the company, and to adjust them to ensure the desired state after the investor's entry—whether it involves establishing the rights of partners or internal compliance mechanisms. Smaller companies, in particular, are often closely tied to their founders, which can pose challenges—especially if the management and functioning of the company are heavily tailored to a specific individual associated with the company. Therefore, it is advisable to select the optimal management model for the company before the investor's entry and to familiarize business partners and employees with it.

Always be prepared for the worst

When a new investor enters the company, you can never be completely certain that everything will go smoothly or that the existing partners will fully agree with the new investor on all matters. Therefore, it is prudent to consider all scenarios from the outset—including the worst ones—and to adjust all contractual documents related to the transaction as well as the documents establishing the rules for the company's operation to prevent conflicts arising from unclear or missing rights and obligations of the individual participants in the transaction.

It is also advisable to consider the adjustment of exit options from the company and the buyback of shares in case the transaction does not proceed as planned. Therefore, the most important points to remember, in addition to negotiating the terms of the transaction with the investor, are the adjustment of joint decision-making in the company and the mechanisms allowing for the sale of shares.

The foundation known as the Term Sheet

The basic procedures and conditions of the entire transaction are outlined in a document known as the Term Sheet, which typically expresses the intention to proceed with the transaction and includes information about the shares being transferred and their price. It will also specify the timing of the transaction, indicating whether it is a one-time or phased transfer.

When finalizing the Term Sheet, it is advisable to agree on the basic conditions and to incorporate these conditions bindingly into the document. Term Sheets may also include a range of other obligations, such as non-competition clauses, confidentiality agreements, due diligence rules, outlines of contractual documentation, liability for damages, and cost allocation.

In the Term Sheet, in addition to the aforementioned conditions, the non-competition clause for partners is typically addressed, as well as the adjustment of breaches of transaction obligations by one of the parties, the obligation of confidentiality (if not agreed upon in a separate agreement), the investor's right to conduct due diligence in the company, or an examination of the company's operations and potential risks, and the corresponding obligation of cooperation, outlines of further contractual documentation, issues of liability and the binding nature of individual agreements, and possibly exclusivity (i.e., committing not to negotiate the investment in the company with anyone else) and subsequently practical matters such as cost allocation or governing law.

The Importance of the Shareholders’ Agreement (SHA)

One of the key documents that helps prevent future disputes between the investor and existing partners is the Shareholders’ Agreement (SHA). This document details the relationships between existing partners and incoming investors and establishes rules regarding the exercise of their rights within the company, particularly:

·      Decision-making powers – which decisions require the consent of the investor or other partners.

·      Transfer of shares – rules for the sale of shares, preemptive rights, tag-along rights, or drag-along obligations.

·      Profit distributions – how and in what proportion dividends will be distributed.

·      Non-competition clause – restrictions on the activities of partners in the same or similar field.

A well-structured SHA significantly reduces the risk of future disputes and ensures transparent functioning of the company after the investor's entry. You can learn more about SHA here.