A key to successful relationship between a startup and its investors is the careful crafting of the legal structure of the investment transaction. Venture capital investing is a long-term commitment of support to a startup. The legal documents must foresee the evolution of the startup from a new venture stage to a publicly held company or viable acquisition target. The investment documents represent a charter of the legal rights of the parties spanning the growth cycle of the startup. They also set the tone of the relationships between the founders/management and the investors of the startup, helping to resolution their often differing concerns.
1. Reasonable reward based on the risk they undertake and the startup's stage of development;
2. Sufficient control of the development of the startup (Board of Directors; negative covenants on mergers or acquisitions, distributions to shareholders, creation of debt;
3. Rights of first refusal in future rounds of financings;
4. Registration rights to insure liquidity;
5. Minimization of taxes resulting from various types of cash flows to investors (cumulative dividends on preferred shares versus interest income on debt);
6. Minimization of cash flow drain on the startup during its development;
7. Future yield;
8. Protection and liquidity if and when the startup goes public, gets acquired, stagnates or becomes insolvent;
9. Voting control if and when performance of the startup is below expectations and management team has to be replaced;
10. Priority rights in the event of liquidation, dissolution and insolvency.
1. Flexibility in operating and strategic control of the startup;
2. Liquidity and financial rewards for creating the startup;
3. Adequate working capital to achieve goals of the startup;
4. Minimization of tax exposure for buying “cheap stock”' when founder/managers of the startup have no cash to pay taxes.
Mutual Concerns of Investors and Founder/Management
1. Flexibility of the legal and financial arrangements to adapt for future capital needs;
2. Share incentives for management through pricing differentials on shares held by employees versus shares held by investors to provide “cheap equity”' for management;
3. Retention of shares inside the startup if management departs;
4. Attractiveness of the startup balance sheet for commercial lenders;
5. Retention of key employees through adequate equity participation and incentives.