As part of any investment discussion, you’ll hear people use a number of technical and legal terms. The jargon can be complicated and opaque to those unfamiliar with it. It’s not immediately obvious after all what a liquidation preference is, or and how anti-dilution rights might affect you. To understand what you’re agreeing to and the implications of those terms for you, you’ll need a clear sense of what they mean. To help with that, our friends at Osborne Clarke have come up with a glossary to help you understand some of the terminology most often used in venture capital investment contracts and term sheets.
The act of allotting new shares to shareholders. Shares are also “issued”. There is a technical distinction between allotment and issue of shares, but in practice they are usually used interchangeably.
A provision within a company’s ARTICLES OF ASSOCIATION which gives an existing investor the right to additional “bonus shares” in the event of a DOWN ROUND. The investor is usually not required to pay for the bonus shares issued to it. The effect of the allotment of bonus shares is to adjust the average price per share paid by the investor to take into account the DOWN ROUND by either rebasing the price per share to the same price paid by the new investors, or by adjusting the price per share to a weighted average. Accordingly, there are different types of anti-dilution provisions (full ratchet, broad based weighted average, and narrow based weighted average) and the effect each of these provisions can have a significant impact on the amount of dilution suffered by the other shareholders. Always take advice before agreeing to a particular type of anti-dilution ratchet.
ARTICLES OF ASSOCIATION
The primary constitutional document of a company containing the rights and restrictions attached to a company’s different share classes (for example, their rights to voting, income, and capital) and certain rights and obligations affecting its shareholders (for example, LEAVER PROVISIONS, DRAG-ALONG RIGHTS, and TAG-ALONG RIGHTS).
An employee that leaves a company in circumstances where he or she is not entitled to retain their shares and is not entitled to receive any value for their shares (other than potentially their NOMINAL VALUE). Bad leavers are generally responsible for the circumstances of their leaving, for example, a resignation or dismissal for gross misconduct or a criminal offence.
A table listing all of the shareholders of a company, the number and class of shares held by each respective shareholder and their corresponding percentage of the voting rights. A cap table will usually contain figures to reflect the actual shares in issue at any time and also on a FULLY DILUTED BASIS.
The adherence by a company with the laws and regulations which are applicable to it and its business.
Information that by agreement or by its nature is confidential and cannot be disclosed to a third party without consent.
CONVERTIBLE LOAN NOTES
Please see LOAN NOTES and CONVERTIBLE SECURITY.
An investment that can be converted into equity or a different class of equity according to a pre-agreed formula. For example, CONVERTIBLE LOAN NOTES are a debt owed by the company which may be converted into shares in certain agreed circumstances. Certain classes of shares are also convertible. For example, investor classes of preferred shares with prior ranking but otherwise limited rights to capital are often convertible into ordinary shares.
A formal written promise stating that certain activities will or will not be carried out. For example, founders are often asked to give post-termination RESTRICTIVE COVENANTS preventing them from, amongst other things, competing with their former employer in the event that they leave the company.
Shares in a company which have no rights to dividends, voting, and only nominal rights to capital. DEFERRED SHARES often come into existence following an automatic conversion of shares where an employee becomes a BAD LEAVER.
A letter from the WARRANTORS to the investors delivered at or prior to closing disclosing exceptions to the WARRANTIES contained in an investment agreement. An investor will generally not be permitted to bring a claim against the WARRANTORS in respect of any matter which was fairly disclosed in a disclosure letter. A bundle of documents is usually attached to support the WARRANTOR’S disclosures.
A distribution by a company of a portion of its profits in cash to one or more classes of its shareholders. Dividends in kind (meaning a distribution of a company’s other assets to its shareholders) are also possible provided that the company has distributable profits equal to the value of such assets.
A round of financing where investors invest shares in a company at a valuation which is lower than the previous fundraising round.
A right enabling a majority of the shareholders to force the other shareholders to join in the sale of a company. Majority shareholders (typically holding more than 50% of shares between them and frequently 75% or higher) can “drag along” other shareholders on a sale and require them to sell their shares to the same purchaser on the same terms. INVESTOR CONSENT may be required for the majority shareholders to exercise their drag-along rights.
The evaluation of a potential investment by an investor through a review of a company’s financial, commercial, operational, and strategic information, as well as the management team, customers, and suppliers of a company. This includes legal due diligence plus any other aspect of the company deemed important for the evaluation of the potential investment (for example, technical due diligence on a business’ proprietary software).
An ownership interest in a company usually represented by shares or a right to acquire shares.
FAIR VALUE (or FAIR MARKET VALUE)
The value of shares in a company which is agreed or determined by a valuer to be the market value of such shares usually on the assumption that there is a willing buyer and willing seller. A GOOD LEAVER is often entitled to FAIR VALUE for all or some of her shares if she is required to transfer the shares when she ceases to be an employee.
FULLY DILUTED SHARE CAPITAL (or FULLY DILUTED BASIS)
The total number of shares that would be in issue following the exercise of all rights to subscribe for shares (for example, CONVERTIBLE LOAN NOTES, SHARE OPTIONS and WARRANTS).
An employee that leaves a company in circumstances where they are not at fault, for example, following a wrongful dismissal, cessation of employment due to ill health, or permanent incapacity or death. A GOOD LEAVER is entitled to receive FAIR VALUE for some or all of her shares if she is required to transfer them on ceasing to be employed (see LEAVER PROVISIONS) or is sometimes entitled to retain her shares in the company.
Rights of an investor to receive regular updates from a company about its financial performance and operations. These rights are usually contained within a SHAREHOLDERS’ AGREEMENT.
The inability of a company to meet its debts as they fall due or where the liabilities of a company exceed its assets. Legal and accounting advice should always be sought where a company is or may become insolvent.
Intangible property that is the result of creative endeavor and owned by a person. A company’s intellectual property (or IP) may include, amongst other things, copyrights, trademarks, logos, design rights, patent rights, database rights, and software rights. A company may own or license it from third parties the IP it needs to operate its business. It may also license out its own IP to third parties or, as part of its business, create, and assign IP to third parties.
An agreement between a company and an investor regarding the subscription for shares in the company by the investor. The founders and management team of the company may also be party to the investment agreement (frequently as WARRANTORS).
The consent of one or more investors to certain actions of the company which are deemed sufficiently significant that an investor requires an effective veto over the action, usually required under the terms of a SHAREHOLDERS’ AGREEMENT. This may include RESERVED MATTERS. Investor consent is often granted by a specified majority of investors by number of shares held (for example, investors holding 60% of the shares between them).
ISSUED SHARE CAPITAL
The total of a company’s shares in issue held by shareholders from time-to-time.
Provisions contained in the ARTICLES OF ASSOCIATION either requiring an employee shareholder to transfer their shares back to the company, to the other shareholders or a third party designated by the board or providing for the automatic conversion of their shares into DEFERRED SHARES if the employee shareholder ceases to be employed by the company. The number of shares to be transferred and the price payable to the departing shareholder will depend on whether they are a BAD LEAVER or GOOD LEAVER. (Also referred to as “Compulsory (or Mandatory) Transfer Provisions”).
A provision in the ARTICLES OF ASSOCIATION governing how different classes of shares rank and are entitled participate in the proceeds available for distribution on a return of capital (such as a liquidation of the company) or a sale of the company. Also referred to as a “pref stack” or “waterfall”.
A form of debt instrument. Loan notes are essentially borrowing by a company which can be transferred by the lending investors. Loan notes are frequently issued on terms that they can be converted into shares (CONVERTIBLE LOAN NOTES) either at the election of the investor or automatically in certain agreed circumstances, such as company’s next round of funding. Conversion essentially means the debt owed by the company to the loan note holder is set off against the amount which would otherwise be payable for the shares allotted to the loan note holder.
A condition whereby a shareholder is prohibited from selling or transferring their shares to another party, usually for a specified period of time.
The basic par value of a share, for example £0.01 or £1. NOMINAL VALUE is often less than the FAIR VALUE of a share.
Equity reserved for employees, directors, and other advisers over which a company can grant SHARE OPTIONS. An OPTION POOL may be included on a CAP TABLE but does not form part of the ISSUED SHARE CAPITAL until the SHARE OPTIONS are exercised.
A basic share with voting rights and rights to capital and income. Ordinary shares rank behind PREFERRED SHARES in a LIQUIDATION PREFERENCE and are not redeemable.
A transfer of shares which is not subject to PRE-EMPTION RIGHTS and can be made without INVESTOR CONSENT. PERMITTED TRANSFERS often include transfers to family members and family trusts for estate planning purposes and are defined in the ARTICLES OF ASSOCIATION.
Rights held by shareholders to acquire shares before they can be offered to a third party on either an ALLOTMENT of new shares or a share transfer by an existing shareholder. Pre-emption rights are frequently pro rata to a shareholder’s existing holding (so if a shareholder holds 10% of the ISSUED SHARE CAPITAL, they will be entitled to at least 10% of the shares to be allotted or transferred) although certain investors insist on a priority right (meaning that they can take up the shares being offered ahead of other shareholders). Exceptions to pre-emption rights include the grant of SHARE OPTIONS (and the resulting shares when such options are exercised) and PERMITTED TRANSFERS.
A class of shares with preferred rights, often subscribed for by institutional investors (such as venture capital funds). PREFERRED SHARES frequently rank ahead of ORDINARY SHARES in a LIQUIDATION PREFERENCE and may have preferred rights to dividends or other rights attached (such as redemption rights, conversion rights, and enhanced voting rights). Also referred to as Preference Shares.
The value of the company before the relevant funding round.
A company’s PRE-MONEY VALUATION plus the amount of funding received on the relevant funding round.
RESERVED MATTERS (or CONSENT MATTERS)
Certain actions of the company which are deemed sufficiently significant that they require INVESTOR CONSENT and usually set out in a SHAREHOLDERS’ AGREEMENT.
A decision of the company which, due to the requirements of law, the ARTICLES OF ASSOCIATION or a SHAREHOLDERS’ AGREEMENT is required to be approved by a requisite number of the existing shareholders of a company. An ordinary resolution requires the approval of the holders of a majority of the voting shares (more than 50%) and a special resolution requires the approval of a majority at least 75%. RESOLUTIONS are either approved at a general meeting of the shareholders of a company by a vote or in writing signed by the requisite majority of shareholders.
A set of restrictions imposed on employee shareholders (and sometimes other shareholders) for a specified period following termination of their employment prohibiting them from being interested in competing businesses or poaching customers, suppliers, and staff from the company. Usually contained within a SHAREHOLDERS’ AGREEMENT or INVESTMENT AGREEMENT.
An agreement for a party to subscribe for shares in a company at certain stated times or during an express period at an agreed price (or using an agreed formula to calculate the price). Options are often used as a way of attracting and retaining talented employees to a company early in its lifecycle. Options will be included in the FULLY DILUTED SHARE CAPITAL of a company. Options can also be granted by a SHAREHOLDER over part or all of its shares in a company.
Each owner of at least one share of the company.
An agreement entered into by all or some of the shareholders of a company which governs certain aspects of the relationship between the shareholders and the company. Typical provisions include INFORMATION RIGHTS, RESERVED MATTERS, and the composition of the board of the company. New shareholders may be expected to sign a deed to adhere to the agreement.
A right protecting minority shareholders which enables them to sell their shares on the same terms as shareholders holding a majority of the shares (usually more than 50%) if the majority wish to sell their shares.
A document (also known as ‘heads of terms’ or ‘letter of intent’) which sets out the principal terms of a transaction (for example, an investment, or acquisition of shares). This will usually not be legally binding except for certain provisions, such as confidentiality and exclusivity.
A shareholder whose shares or options are subject to vesting will not be able to enjoy the rights attached to those shares or to exercise the options until they have vested. Shares and options typically vest according to a specified timetable or subject to the achievement of certain milestones.
A contractual right to subscribe for shares in a company at certain stated times or during a specified period at an agreed price (or using an agreed formula to calculate the price). Similar to a SHARE OPTION, but warrants must be issued by the company itself (rather than another shareholder over his own shares) and are generally transferrable.
A contractual assurance about a matter or circumstance. In an INVESTMENT AGREEMENT, the company and management often give warranties to the investors about the company and its business. If a warranty is incorrect (and the persons giving the warranty have not disclosed those exceptions to the warranty), the person with the benefit of the warranty will have a claim for breach of contract.
Post produced in partnership with Osborne Clarke.