UK Private Capital (formerly, the BVCA) aims to standardise
\nSeries A transactions and focus negotiations on (fewer) key points.
\nThe increasing use of AI to generate initial drafts based on
\nstandard terms like these, which are effectively created by VCs and
\ntheir lawyers, will likely only accelerate this trend.<\/p>\n
While not necessarily unfair, this raises the question:
\nwho is looking out for the interests of the
\nfounders? Currently, founders lack a formal platform with
\nindustry-accepted tools to negotiate effectively. This article aims
\nto provide some guidance.<\/p>\n
1. Leavers and (Reverse) Vesting<\/p>\n
On leaving the company the customary-ish position here is that
\nall the shares held by a founder are forfeited if that event is
\nowing to fraud, gross misconduct or breach of any
\ncompete-restrictions or any employment agreement (in other words, a
\nbad leaver). On departure for any other reasons (that is, a good
\nleaver) the forfeited shares are only those that are not vested.
\nThe standard vesting period is typically 36 or 48 months on a
\nlinear basis save that there will be likely be an initial 12 month
\ncliff where no vesting applies.<\/p>\n
What may additionally be negotiated is that:<\/p>\n
– Resignation: the UK Private Capital terms
\nflipped in 2023. Previously resignation would amount to being a bad
\nleaver event. It is to be applauded that an industry body
\nrepresenting VCs was able to consider that a resignation should not
\nnecessarily lead to a founder losing everything. Sadly, some term
\nsheets we see resile from this and re-flip. This has led to
\nintermediary positions where, for example, the founder must not
\nresign during an initial period but thereafter can resign and be
\nconsidered as a good leaver (though this tends to apply to more
\nmature businesses).<\/p>\n
– Pre-vesting: there can be an iterative
\ndiscussion that the founders have already earned some of their
\nshares and those earned shares ought not be subject to vesting.
\nThis tends to apply to the “older” companies or to
\nfounders who have already navigated (even if only in part) vesting
\nprocedures in a prior seed round. This will be a Series B
\nconsideration, but we have seen this apply on a Series A. Be wary,
\nthis may be implemented as an adjustment to the vesting
\npercentages; vesting in its standard format only applies to a good
\nleaver \u2013 forfeiture of all shares on a bad leaver event does
\nnot look at the vesting schedule, so if a bad leaver is intended to
\nkeep shares a specific change must be made. Lastly, it should be
\nclear to all these provisions should not apply to shares purchased
\nor to be purchased by the founder for value.<\/p>\n
2. Other thorny deal terms<\/p>\n
Lastly, here are some thoughts on some common areas to consider
\nin investor-driven financing documentation. Of course there are
\nmore:<\/p>\n
– Lead investor: we are seeing fewer term
\nsheets with the principal investor being prepared (at least,
\nexpressly) to take the “lead investor” role. Without it,
\nalignment can become problematic if there are multiple investors
\ncontributing meaningful amounts. Please consider carefully at term
\nsheet stage the process as between investors and the likely input
\nfrom those that are less involved. Some of the terms defined by
\nreference to share percentages need to be considered too. For
\nexample, if it is likely that some VCs will be marginally below an
\ninvestor director appointment right threshold, how would the
\nbalance on the board be impacted if on a pre-emptive round that
\nthreshold is exceeded? Will there be further VC appointee director?
\nOr does this remain as previously? Does an observer right need to
\nbe considered? Moreover, when making warranties, will these be made
\nto all the investors or just the VC that ought to have been the
\nlead? If more than one, it would be an odd conclusion if one
\ndecides to make a claim and the other(s) decide to pass? These may
\nseem like the driest form of lawyers’ points, but if not
\nresolved at the outset more time can be lost later when less of it
\nis available.<\/p>\n
– Anti-dilute: this form of down round
\nprotection has now been the market standard for 20 years plus.
\nThere are two types, one used in the US (and adopted by the NVCA)
\nand another used in Europe. It is regrettable that the latest round
\nof changes the UK Private Capital terms were not adjusted to adopt
\nthe NVCA model, for that it is the original and is more widely-used
\n(including across the Middle East). It is also simpler
\nadministratively. There are many articles on the internet to
\nexplain the differences; but what is important to note is that both
\nlead to a balancing equity correction in favour of the VC if a down
\nround occurs. The rebalancing is very rarely substantial unless the
\ndown round is significant; this must therefore be primarily
\nregarded as an anti-embarrassment provision. I have written a lot
\nabout these clauses (as in my experience not many actually read
\nthem), but I will restrict myself to:<\/p>\n
\nA sunset provision should apply on the basis that there is no
\nlonger any embarrassment. This can be after a period of time
\n(suggest, 12\u201324 months) or upon the occurrence of a higher
\nprice round. In any event Series B VCs (who were not part of the
\nSeries A) are always loath to agree to this compensation for
\nearlier round investors.
\n
\nThe underlying math is designed for one application only. This
\nis because the corrective measure arising from a prior down round
\nin not actually factored into the weighting used in the formula,
\nunless adjusted. In nearly all circumstances, when the formula is
\nretained that adjustment is not made. It is possible to argue that
\nfew really understand the formula and even fewer actually care
\nabout the result it delivers other than the fact that it delivers
\none (and it is “standard”). But one thing is for certain,
\nthe founders (as they are rarely also investors) are diluted the
\nmost.
\n
\nWe are seeing instances where these terms are integrated into
\nseed rounds. These clauses were designed for Series A and onwards;
\nwe would caution founders against agreeing to them on an earlier
\nfinancing where the underlying valuation is less formulaic.
<\/p>\n
– Investor consents: even though investor
\nconsents now tend to take a common form, I still am asked about
\nthese. They are a major change in governance for the founder
\n(especially those who have not undertaken a meaningful seed round).
\nThe three areas on which I ask founders to consider are:<\/p>\n
\nThe capital related consents, that is the need for an investor
\nconsent to agree to issue shares or rights to shares. There is a
\nlot to unpack here, including the legitimacy of a VC being afforded
\na veto in circumstances where they have the ability to pay-to-play
\nthrough pre-emption but decline. But that is for another day; the
\nveto has become “standard”. What is left is that the
\nfounders should consider whether further issuances are contemplated
\nshortly after closing or whether any option plan is to be
\nimplemented so that these can be excluded from the consent right
\n(essentially, they are pre-approved);
\n
\nThe business-related consents, as these come from a customary
\ntemplate, these should be assessed as whether they are appropriate
\nor germane to the business. If they are not, the offending consent
\nrights should be amended or deleted; and
\n
\nThe nature of the investor majority which decides matters is
\ndifferent for each business. If it relates to a percentage and that
\npercentage is too high, this will mean that smaller investors will
\nwield power beyond that merited from the capital they have
\nintroduced.
<\/p>\n
– Founders’ warranties: the UK Private
\nCapital terms are based on warranties being given by the company.
\nWe see the VCs departing from their own standard terms, by
\ninserting that the warranties must additionally be given by the
\nfounders. Standardisation here is problematic, this is because the
\nlimitations (of liability) set out elsewhere in those terms are
\nbased on the warranties only being given by the Company. Additional
\nterms need to be added to protect the founders here as (for
\nexample) they should have a liability capped at a much lower value
\nthan the total funds raised. We commonly see drafts where these
\nprotections are (hopefully, mistakenly) omitted in the opening
\ndraft.<\/p>\n
– Deal fees: information on deal fees is less
\nwidely available and is to some extent anecdotal. As to arrangement
\nfees there is a fair amount of disagreement between VCs as to
\nwhether they should be chargeable at all and, if not, whether they
\nare to be baked into the underlying valuation. We find that some of
\nthe larger VCs with an international footprint are less keen on
\ndeducting an arrangement fee from introduced funds. Elsewhere we
\nsee fees calculated at 2\u20133% of those introduced funds, though
\nwe are seeing a slight nudge beyond that from time to time. A
\ncontribution to VC legal fees is typically capped at the first
\n\u00a330k of fees accrued. Founders who have been through a seed
\nround will be accustomed to a quarterly monitoring fee (at say
\n\u00a320k\u2013\u00a330k per annum). This mostly (but not
\nalways) falls away on a Series A. For those VCs with \u2013 let us
\nsay \u2013 a PE heritage, this monitoring fee may be replaced with
\na director’s fee contribution. This can be up to \u00a350k per
\nannum (which in our opinion is on the high side). In all cases, we
\nsuggest that these fees should at least be discussed, the final
\nagreement being heavily coloured by the weight of bargaining
\npower.<\/p>\n
3. “We want to reward our people, but we run the
\nbusiness”<\/p>\n
It is surprising to me that non-voting shares are not introduced
\nat an earlier stage. The first gating moment tends to be upon the
\nimplementation of (if in the UK, a tax-efficient) option scheme. In
\nmost (but admittedly, not all) instances shareholders other than
\nthe founders who become stakeholders at an early stage are less
\ninterested in voting and management. The chief requirement is a
\nright to a future economic return, perhaps as a compensation for
\nreduced income. It’s an easy change to the articles and gives
\nmore decision-making authority to the founders through the later
\naspects of their corporate journey.<\/p>\n
4. Housekeeping: the Register of Members, Cap Table, and Share
\nCertificates<\/p>\n
Many of my founder clients do not appreciate that their company
\nmust have a Register of Members. This is distinct from making
\nfilings at Companies House and is not the same as a cap table. As a
\nmatter of law the entries in the Register of Members are the
\nprimary evidence as to identity of the shareholders and the shares
\nthey own. The cap table must reflect this; it is not supposed to be
\nthe other way round. We are now beginning to see tools which can
\nhelp with these tasks. We recommend creating the Register at an
\nearly stage when there are fewer shareholders. Recalling the
\nrequisite detail at a later stage is sometimes not straightforward.
\nBefore the term sheet stage, please ensure any promises to issue or
\ntransfer shares are fulfilled or clearly documented for completion
\nat closing. Unresolved share promises often surface during
\nfinancing rounds. This can frustrate VCs, risks losing momentum and
\ncan delay closing.<\/p>\n
As to the cap table, it is common to see shares and options
\n(allocated and unallocated) being treated together. This has a
\nclear function in terms of calculating fully-diluted share capital.
\nBut it is more useful if the totals are also calculated separately
\nby reference to shares, allocated and unallocated options. In terms
\nof consent rights and voting, these will relate to (voting) shares
\nonly. The definitive documents when it comes to resolutions and
\nconsents will refer to shares only. Voting percentages are highly
\nrelevant to the definitive documents, so \u2013 to avoid
\nsurprises, especially for those heading directly to Series A
\n(without a prior seed round) \u2013 it is preferable to have these
\nset out clearly at term sheet stage.<\/p>\n
Share certificates are an outdated legacy. They are not legal
\nproof of ownership and serve little purpose. Shareholders
\nfrequently lose their share certificates and replacing them is an
\nadministrative burden that can be complicated by uncooperative
\nshareholders. A simple one line change to the articles can be made
\nto enable shares to be uncertificated with certificates being
\navailable only on request (i.e. to a VC).<\/p>\n
5. Diligence and Disclosure; they are not the same.<\/p>\n
We get asked a lot about this. In short:<\/p>\n
– Diligence is the exercise whereby an investor seeks
– Disclosure is a formal response to the warranties (broadly,
These are arduous (and frankly, boring) exercises for the
6. “What? The company does not own the intellectual
A general principle of English law is that the first owner of
Early-stage companies often use contractors rather than
Since intellectual property is often a company’s primary
7. Initialisms: CLNs and ASAs<\/p>\n There is plenty on online commentary on (debt and equity-based)
When using CLNs, it is crucial to pull out all stops (or the
\ninformation about the company, its assets and liabilities before
\ncommitting to the transaction. This information is provided in an
\nonline data room. On a Series A this is typically run by the
\ncompany with limited involvement from counsel. We recommend that
\nwork is begun on this as the term sheet process starts (and any
\npitch deck must be consistent with those documents uploaded). It is
\nessential that the folders are structured and populated on a
\nlogical basis. Our data room schema can be found here<\/a>.<\/p>\n
\nlegal promises) required to be given by the company and the
\nfounders to the VCs in a Disclosure Letter, which contains
\nstatements of fact to counteract the circumstances where the
\nwarranties are not true. If properly drafted an investor will not
\nbe able to bring a warranty claim in respect of that disclosed
\nmatter. Previously, a general disclosure of all documents in the
\ndata room was sometimes accepted, but the standard has reverted:
\nfounders must now provide specific, detailed disclosures for them
\nto be effective.<\/p>\n
\nfounder, more so than on a seed round. If the company has reached
\nan element of maturity by Series A, consideration should be given
\nas to whether a person other than the founders has sufficient
\nknowledge to front this exercise, thereby alleviating the burden on
\nthe founders.<\/p>\n
\nproperty”<\/p>\n
\nany intellectual property is the person who designed or created it.
\nThe important rights here are usually copyright and\/or patents. One
\nof the exceptions in in both cases is that the company will be the
\nfirst owner if the copyright or patent is designed or created by
\nemployees in the normal course of their employment.<\/p>\n
\nemployees. These contractor agreements must assign all intellectual
\nproperty rights to the company. Correcting this oversight later
\nwith a separate assignment document can be challenging if the
\ncontractor is not easily contactable or has emigrated to the
\nfoothills of the Carpathians.<\/p>\n
\nasset, VCs will almost certainly require ownership issues to be
\nresolved on or before closing.<\/p>\n
\nCLNs and ASAs. My colleague, Mark Ward, has provided a good summary
\nwhich can be found here<\/a>.<\/p>\n
\ntarot cards) to set a reasonable valuation cap. A cap that is too
\nlow can give early lenders an excessive discount. Stacking, that is
\nthe accumulation of multiple CLNs, can be a blight too. VCs may
\nrequire those notes to convert on a same price paid basis.
\nAlternatively, they only come in at a much lower valuation (nearer
\nto that cap) or simply walk away if they feel that value has been
\nexcessively eroded.<\/p>\n