Some Helpful Advice for Both the Entrepreneur and the Investor
Published in Globes
by Moshe Kahn*
Negotiations for investing in a high-tech company encompass more issues than just a discussion of the deal's commercial terms. One of the main issues included in the negotiations is the relationship between the parties the morning after the deal, i.e., their joint management of the company after the investment. For the most part, this involves defining the management and voting rights, protections for investors, restrictions on future sales of stock, etc.
These matters will find legal expression in the company's new articles, which will go into effect as soon as the investment is made, and in the stockholder's agreement, which will be signed when the deal is closed.
Ostensibly, these things are clear and anticipated but in actuality, from my experience as someone who sometimes represents the entrepreneurs and sometimes the investors or the company, sometimes one of the parties cannot see the legitimate considerations and expectations of the other party and thus is liable to impede the successful conclusion of the negotiations.
Below are several insights that will help each of the parties to the pre-investment negotiations to conclude successfully.
For the entrepreneurs / current stockholders
- Prepare the business plan so that it is based on realistic data. Be sure that the data appearing in the forecasts is as up-to-date as possible. Remember, investors give real credence to the business plan and that plan is the basis for their expectations for maximizing profits on their investment.
- Put all your cards on the table and deal with the investors with complete transparency. Tell them all the facts and disclose to them and to their representatives all the relevant information. If the investors discover, during due diligence, that you have not been properly forthright with them, it is reasonable to assume that they will back out of the deal. If, after the investment, they discover findings that you did not disclose during negotiations, you will be open to a lawsuit.
- There is no need to elaborate on the importance of bringing investment capital into your company and, in the case of a strategic investor, the added value that he is expected to bring to the company in its fields of operation. It is therefore important for you to remember that the investors' primary interest is to maximize the profit on their investments. That is their main objective. The success of the products or other successes and achievements of the company is secondary to the investors' main goal. It is therefore important that already at the negotiations stage, you show the investors how it will be possible in the future to maximize the profits on their investments and what the company's strategy will be to accomplish that.
- Don't be afraid of losing exclusivity in managing the company. Remember, the investors also have a right to influence the manner in which the company - which is financed with their money - is operated. Additionally, it is highly probable that the experience of the investors or their representatives, as well as their contacts, will help you to manage the company better and to promote its business.
- Before you reach an impasse due to disputes over the scope of dilution of your holdings in the company, it is best to remember that dilution is justified when it is implemented in exchange for the increased value of the company. It is better to have minor holdings in a company of great value than the other way around.
- Remember, the investment is designed to raise the value of the company, so the percentage of your holdings in the company after the investment is important, but the future value of those holdings is even more important.
- The right to receive ongoing information from the company is a basic, fundamental right of the investors. Don't argue unnecessarily over the investors' demand to receive information.
For the investors
- Don't surprise the entrepreneur. At the start of the negotiations, present him with all your future plans for the company, including the extent of your involvement in its ongoing operations. It is best to clarify differences in approach right at the beginning of the negotiations. That way you will know if there is a possibility of joint management.
- Remember, the entrepreneur/shareholders have brought the company to where it is now. They have apparently succeeded to some extent, otherwise, you would not be considering investing in the company at all. Don't make things unnecessarily difficult with rigid regulatory demands regarding the future management of the company, and setting inflexible restrictions on the decision-making entailed in its ongoing management. Let the existing management continue to lead the company as long as it continues to do the work properly and report to you as required.
- Reserve the right of control and supervision for important junctures by, inter alia, obtaining veto rights on the major decisions for the company's future. However, don't demand majority rights in the company in exchange for a minority investment.
- The company's employees, particularly its executives, are the main asset in which you are investing. Don't interfere unnecessarily in the employment conditions of the company's officers who are subordinate to the CEO. Take into account that suitable employment conditions will ensure the long-term integration of key employees in the company.
- You are fully entitled to maximize the profits on your investment, so you will be justified in demanding preferential rights for your stock in the company. However, it is important for you to remember that the company's other stockholders have the right to exercise their holdings. The "double-dip" method (which, when the company is sold, enables the investors to first take the agreed yield on their investment from the proceeds of the sale, and afterward divide the balance with the rest of the stockholders) is not always fair. An agreement can be reached on first priority for investors in returning the investment, with the addition of the agreed-upon yield, and afterward on distributing the balance to the other stockholders.
- A demand to restrict the sale of the entrepreneurs' holdings is legitimate, at least during the initial period, however, later on, you should be flexible so that the entrepreneurs will also be able to benefit from the fruits of their labor.
- Its there are a number of investors, see to it that their representation on the company's board of directors is limited. An oversized board of directors is cumbersome. A voting method should also be established which will ensure a uniform position by all the investors on the substantive issues by majority rule. One investor should not be allowed to hold the company and the other stockholders by the throat when major decisions must be made for the future of the company.
*Moshe Kahn specializes in the field of corporate law. He is licensed to practice law both in Israel and in the U.S.. www.kahn.co.il
