The Investor Rights Agreement, part of the National Venture Capital Association‘s templates for a preferred equity round for a private equity company, does exactly what it says it does. It defines the Investors rights upon execution of the agreement. This Agreement governs the rights of the Investors to force the Company to register shares of Common Stock issuable to the Investors, to receive certain information from the Company, and to participate in future equity offerings by the Company. The important points are as follows:

  • If 51% of the voting shareholders vote, they can force the company to file for an initial public offering unless the Board of Directors votes against such an action because it would be detrimental to the company. There are very clear circumstances upon which the BOD must validate this refusal.
  • The Agreement lays out clear responsibilities for the company and for the shareholder including “lock-up” periods. A lock-up period typically begins on the day the company is registered as a public company and lasts for six months. In this period, the shareholders agree not to sell their shares on the public market. This is intended to prevent inappropriate shareholder activities (such as forcing an IPO in order to short a stock) and to prevent sending signals to the market that could be misunderstood, such as a mass sell-off that might taint the stock in the market’s perspective.
  • The Agreement limits the transferability and pledge/sale of the shares that would violate applicable SEC securities law and precedent.
  • The Agreement outlines the “major investor” (investors that have committed a threshold of capital, typically $50,000) information rights annually:
    • A budget to be released with in 30 days of a new fiscal year for the forgoing 12 months.
    • A balance sheet as of the end of the prior year
    • Statements of income and of cash flows for the prior year and a comparison and explanation of differences between the actual amounts as of and for such fiscal year and the comparable amounts for the prior year as defined in the budget for the year
    • A statement of stockholders’ equity as of the end of the year
    • All audited and certified by independent public accountants financial statements
  • The Agreement outlines the “major investor” (investors that have committed a threshold of capital, typically $50,000) information rights quarterly:
    • Unaudited statements of income and cash flows for the last fiscal quarter (GAAP)
    • Unaudited balance sheet as of the end of the last fiscal quarter (GAAP)
    • Access to a capitalization table suitable for determining the individual investor’s percentage ownership of the Company.
  • Each Major Investor has the right to examine the Company’s records presuming the holder is not a competitor.
  • Each Major Investor agrees to a confidentiality agreement for Company information.
  • Major investors retain the right to make first offer on a new round of equity capital once the shareholders approve a new round of financing.
  • Each Major Investor has rights to purchase future securities from the company sufficient to hold his percentage ownership each time the company raises equity capital.
  • The Agreement forces the Company to sign employee agreements with its key managers.
  • The Agreement forces the Company to create a stock incentive pool for management and contractors.
  • The Agreement provides certain investor protections preventing the BOD from taking action in the following ways:
    • Make, or permit any subsidiary to make, any loan or advance to, or own any stock or other securities of, any subsidiary or other corporation, partnership, or other entity unless it is wholly owned by the Company;
    • Make, or permit any subsidiary to make, any loan or advance to any Person, including, without limitation, any employee or director of the Company or any subsidiary, except advances and similar expenditures in the ordinary course of business or under the terms of an employee stock or option plan approved by the Board of Directors;
    • Guarantee, directly or indirectly, or permit any subsidiary to guarantee, directly or indirectly, any indebtedness except for trade accounts of the Company or any subsidiary arising in the ordinary course of business;
    • Make any investment inconsistent with any investment policy approved by the Board of Directors;
    • Incur any aggregate indebtedness in excess of $1,000,000 that is not already included in a budget approved by the Board of Directors, other than trade credit incurred in the ordinary course of business;
    • Otherwise enter into or be a party to any transaction with any director, officer, or employee of the Company or any “associate” of any such Person, except for transactions contemplated by this Agreement, the Purchase Agreement, or transactions made in the ordinary course of business and pursuant to reasonable requirements of the Company’s business and upon fair and reasonable terms that are approved by a majority of the Board of Directors;
    • Hire, terminate, or change the compensation of the executive officers, including approving any option grants or stock awards to executive officers;
    • Change the principal business of the Company, enter new lines of business, or exit the current line of business;
  • Sell, assign, license, pledge, or encumber material technology or intellectual property, other than licenses granted in the ordinary course of business; or
    • Enter into any corporate strategic relationship involving the payment, contribution, or assignment by the Company or to the Company of money or assets greater than a given monetary threshold.
  • The Agreement sets the frequency of the BOD meetings.

ACG takes advantage of the language provided in the 2010 NVCA model documents. The advantage of using this agreement is clear:

  • These documents are the standard in the industry and allow the Company to easily close capital under terms that are already acceptable to professional investors.
  • These documents are standard in the industry and any securities lawyer worth his salt understands them, their impact, and liabilities.
  • These documents mean a easy transition between multiple rounds of funding for the Company.

For more information:

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Copyright Appalachian Investors Alliance, Inc. 2018
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