By Omoruyi Osagie Edoigiawerie, Esq
Money is the lifeline of any business, without funding it is practically impossible to expand or even grow your business. When starting a new company, one of the most important issues to handle is securing an appropriate financing structure for the company. Entrepreneurs are faced with various types of solutions – one of them is Venture Capital (VC).
Venture Capital (VC) is a form of private equity and a type of financing provided to start-up companies and small businesses that are believed to have long-term growth potential. It does not always take a monetary form; it can also be provided in the form of the provision of skill or technical expertise.
Now, venture capital is typically provided to small companies with potential for profitable growth, or to companies that have shown fast growth and profitability and need funds for expansion.
Many times start-ups assume that all they need is a disruptive business concept and a clear growth path. But this isn’t always the case. Typically, investors take a risk by providing investment support and that is why start-ups need to show a strong potential for productivity and returns on their investment.
Nigeria has many start-ups springing up and doing phenomenal and innovative work. It has thus become increasingly popular for these start-ups to resort to Venture Capital as a primary source for raising money for their business.
According to recent data from Partech and the Big Deal Substack, Venture capital investment in the country has ballooned from a mere $300m in 2018 to a staggering $1.27bn in the first six months of 2021.
What this simply means is that there is an uncommon boom in venture capital investment in Nigeria. From a meagre 18 per cent of Foreign Direct Investment (FDI) in 2018 it has now risen to 546 per cent of FDI.
Legal issues to consider before securing venture capital financing
So as a Start-up there are essential things you need to do to attract venture capital and even more importantly, there are essential things that venture capitalists or angel investors want to see before they invest in your Start-up.
Below are five of the most important legal issues that venture capitalists and angel investors are likely to review in a standard due diligence process before deciding to invest in any Start-up or early-stage company;
Corporate Governance
Whether your company is a corporation, limited liability company (LLC), or partnership, when seeking investment, you should ensure the following:
a) That the basic governance structure is finalized and agreed to by all stakeholders;
b) That the organizational documents are adequate and complete;
c) That all agreements of the board of directors/managers or shareholder actions are properly reflected in the minutes;
d) Additionally, the company should be treated as a separate entity (and not as the alter ego of the founders or another business);
e) And the equity records of the company should be complete.
Upon deciding whether to make a venture investment, an investor will likely request a review of these organizational documents to gain a better perspective of the actions the company has taken in the past.
One of the most common mistakes start-up companies make is their failure to properly address the ownership structure of the Start-up and measure of equity owned. These issues can be avoided by seeking legal counsel at the onset to ensure that it is done correctly.
2. Shareholder Agreement
The easiest way to make clear what all of the equity holders’ rights are in a company is to have a shareholders’ agreement. Some of the pivotal provisions of this agreement include:
a Voting arrangements,
b) Restrictions on share transfer,
c) “Tag and drag” rights in the event of a sale,
d) Anti-dilution provisions and
e) Rights of first offer or refusal.
In my experience, many start-ups discuss these issues verbally. Some even prepare drafts but never get to the signing stage and this leads to uncertainty for subsequent investors in the company to ascertain what rights all parties involved have.
The absence of a final and signed shareholders’ agreement may also allow certain equity holders to block a potential venture investment and to hold the transaction hostage unless they are given preferential rights.
3. Intellectual Property
If your company is centred around or built upon its intellectual property, then there must be no confusion about the ownership of intellectual property associated with the company. An investor will expect to see signed intellectual property assignment agreements, assigning any potential ownership rights or claims to the company. Furthermore, depending on the nature of your intellectual property, you must conduct proper due diligence to confirm that you are not infringing on third-party intellectual property rights.
4. Written Contracts
Although it is not a legal requirement for an agreement to be in writing before it can be enforceable, it is advisable to ensure that all of your material agreements are in writing, contain all important terms, and are properly signed by all parties.
Highlighted below are some of the important agreements that should be in writing:
a) Vendor and supply agreements,
b) Customer agreements,
c) Warranty and guaranty terms and
d) Employment agreements
Before investing, an investor will likely request to review your material contracts to gain a clearer picture of your business’ obligations.
One key thing you must note is that, when negotiating a written contract, some third parties will include certain provisions within the contract, including indemnification, non-compete, license, and limitation of liability provisions which may impact negatively on your company, so be on the lookout for these provisions because they eventually become an issue during investor due diligence and may adversely affect your company’s value to a potential investor. As always, make it a point of duty to get legal advice before you sign a contract.
5. Understanding the Regulatory Issues relating to your business
Manoeuvring the regulatory landscape relating to your business is a must. For instance, if your business is in the tech space, you must ensure that it is in tune with the data privacy laws of the country of Origin and adheres to regulatory provisions. Before investing, investors will want to ensure that your business plan is not endangered due to regulatory concerns. You must seek legal counsel to help you identify any potential regulatory issues and to confirm that such regulatory issues where they exist will not adversely impact your business model.
*After due diligence, what next?
Once due diligence has been completed, the firm or the investor will pledge an investment of capital in exchange for equity in the company. These funds may be provided at once, but more typically the capital is provided in stages. The firm or investor then takes an active role in the funded company, advising and monitoring its progress before releasing additional funds.
*Is Venture Capital Important?
Some may still ask, “Why Venture Capital is important?”, well the answer is simple, Innovation and entrepreneurship are the kernels of a capitalist economy. New businesses, however, are often highly-risky and capital intensive and as a result, external capital is often sought to spread the risk of failure. In return for taking on this risk through investment, investors in new companies can obtain equity and a share in potential company profits. Venture capital, therefore, allows start-ups to get off the ground while ensuring that founders fulfil their vision.
*Conclusion
Venture capital financing can be crucial to the success of a start-up. By understanding the key issues in venture financings, start-ups can increase the likelihood of a successful outcome.
Omoruyi Edoigiawerie, ACIArb (UK), is the Founder and Lead Partner at Edoigiawerie & Company LP, a full-service law firm offering bespoke legal services with a focus on start-ups, established businesses, and upscale private clients in Nigeria. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Edoigiawerie and Company LP can be reached by email at hello@uyilaw.com.
