Looking for an investment, you need to prepare properly. There is a prolonged phase of due diligence followed by a phase of negotiating the terms of the investment and the participation rights of the investor.
Due Diligence Phase
The due diligence phase will include the delivery of:
- a pitch deck on your business model, presenting your team, your vision, the USP of your product, the KPIS of your product, the size of investment you are looking for, including an extended version as well as a confidential information memorandum, which delivers detail of revenue sources, gross margins, customer acquisition costs, product development, etc.;
- comprehensive documentation of your legal affairs, such as complete corporate documentation, key contracts, (key) employment contracts and service contracts, insurance, IP;
- up to date financial information;
- business plan, including a basic description of your business concept, strategic goals and specific actions you plan to implement into your goals, description of your products, services and their advantages compared to the competition and the markets you want to operate in, team and financial needs (there is some overlap with other points raised in this list);
- a financial model consisting of a set of factors which can be varied, such as revenue, pricing, number of customers, spent on customer acquisition, drop rate, etc;
- operating information, including key business operating metrics (usage behavior or the dynamics surrounding the buyers and sellers of your marketplace should be described here), customer satisfaction scores and other forms of customer feedback;
- sales Information, providing a cohort analysis of the revenue streams;
- product information, which may include a description of the product, accompanied by screenshots, a road map for the further development of the product, interacting properly with the business plan;
- proper market research, compromising a customer analysis, a competitor analysis (SWOT analysis and STEP analysis).
All this information needs to be properly displayed so you can share it easily with your investor. There are structures available to help you in display the information. The information should not be revealed immediately but gradually, as the talks advance and become more concrete. You should discuss these matters with a number of investors at the same time. It is important to have a proper understanding of the status of each such discussions. You have to organise yourself well by using the proper tools which allow you to constrain the administrative burden of handling documentation and communication with investors, leaving you still time for your business.
Whilst providing the information to the investor the process of negotiating the terms of the investment by the investor kicks off. You start with a term sheet which very often is provided by the investor, setting out the heads of terms for his investment.
Once the discussions become more concrete you start negotiating an investment and participation agreement. The negotiation includes the discussion about the corporate documentation of the company and may also affect existing contracts with managers, employees, customers, service providers, insurance, IP, etc.
Key issues for the participation are the following items:
- Nature of participation rights. Typically the investor wants to have a right of first refusal to invest in future rounds
- The investor and the original shareholders will negotiate drag along and tag along rights in case of a disposal of shares as well as a right of first refusal to buy any such shares.
- Original shareholders may become subjects to certain vesting periods for their shareholdings.
- Voting rights on decisions will be discussed; in particular it will be negotiated on which decisions the investor or any other shareholder may have a veto right.
- Representation of the investor on the board of directors and the management.
You may also negotiate with several investors in parallel. To keep the administrative burden low it would be nice if you could invite them on the same platform and share with them the information in parallel but making sure that one does not know of the other investor. Equally it would be nice to regulate access to information individually for each investor in line with the respective negotiation stage. You may then also decide for each investor individually whether talks are continued or whether the investor is removed from the platform because you or the investor decided to stop the talks.
At the appropriate time you may remove the restrictions so that the investors willing to invest in your start-up can see each other.
Please make sure that the investment is checked also by a tax specialist. It should be made sure that investment and potential exit are always duly considered from a tax perspective in order to avoid adverse tax consequences as a consequence of the investment structure.
The author of this article is Dr Oliver Waldburg, the founder of Worklean. Worklean www.worklean.com allows you as a start up to structure your processes and documents in a very smart and efficient manner. The features mentioned in the text on visibility restrictions are available on Worklean. Simultaneously Worklean offers templates for free which cover not only the due diligence and investment phase in connection with the participation of an external investor but the entire life circle of a start up from its foundation.
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