Ten Observations from Ten Months of Revised BVCA Model Investment Documents

1. Costs

The updated Subscription Agreement provides that the company will only cover the costs and expenses of the Lead Investor rather than those of all investors up to a capped amount.  However, we are still seeing smaller investors expecting the company to meet some or all of their costs.

More significantly, we are experiencing Lead Investors demanding punitive abort fees in their term sheet, leaving Founders to cover the investor’s due diligence costs in the event of an aborted transaction arising from the investor’s own withdrawal, for example if the company fails to meet VCT/EIS qualifying criteria or there are other disappointing due diligence outcomes, or if the Founders unilaterally withdraw.  There are a number of protections for Founders and companies that can be negotiated (for example, phasing due diligence and/or clarifying materiality thresholds) but it does mean that the term sheet takes on increasing importance – making sure material terms are negotiated and agreed up front – as the abort fee acts as a strong deterrent for the company to withdraw during negotiation of the investment documents themselves.

2. Conversion of convertibles and rolling closes

The new separate model Subscription Agreement helpfully provides for the conversion of ASAs, SAFEs, convertible loan notes etc at the same time as the new money coming in, as well offering more flexibility for closing investment rounds with multiple investors, such as a rolling close option.  This is extremely useful in the current market where the fundraising process is becoming increasingly protracted and the need for fast access to funds is ever more common.  Lead Investors are often taking longer over their due diligence and, once they are comfortable to proceed, Founders do not want to have to wait to secure the whole round before accessing their funds.  The new Subscription Agreement also conveniently includes a mechanism for the Subscription Agreement to terminate in respect of any proposed investor who does not invest by a longstop date without the need for any further documentation.

3. Founder warranties

Under the new model Subscription Agreement, only the Company provides warranties to the investors. This change was intended to reflect growing practice in the UK, particularly at Series A and/or for earlier stage repeat investments.  However, in a cautious macro-economic climate and investor-friendly market, Lead Investors seem to be reverting back to requesting Founder warranties especially for fundraising rounds at the Seed-end of the Series A spectrum.

4. No general data room disclosure

A pro-forma disclosure letter has also been provided by the BVCA under which the contents of any data room or other due diligence documents are not deemed generally disclosed.  Instead, only those documents specifically referred to in the disclosures will qualify the warranties (and only to the extent the matters contained therein are relevant to a specific disclosure).  This change did not reflect the common UK and EU market approach, which tended to accept general disclosure. However, investors do appear to have seized the BVCA’s suggestion and are now asking for specific disclosures for their review, which is a contributory factor in the lengthier fundraising process and reflects a more cautious investment market.

5. Conduct of the business

The updated Shareholders’ Agreement includes several new undertakings focused on enhancing standards of corporate governance and regulatory compliance.  These include undertakings to adopt policies for appropriate workplace behaviour, diversity, anti-harassment and discrimination and an obligation to complete a data protection compliance audit (and implement any remedial action).  There are also a number of ESG undertakings together with a commitment to implement a Sustainability Impact Plan.  It was expected that these undertakings would vary significantly in practice depending on the maturity and resources of the company.  However, with lengthier due diligence processes, we have seen investors asking companies to use this time to ensure that they do have appropriate policies in place (albeit that a pragmatic approach is taken regarding content). Similarly, Founders are reluctant to admit that they are not fully aware of their ESG obligations or may not be operating in full compliance. However, companies must make sure that the undertakings entered into, and policies they are adopting, are realistic and achievable.  We are not tending to see existing investors asking companies to increase their obligations to meet these standards on follow-on rounds.

6. Changes to facilitate further fundraises – pre-emption rights and Articles “drag”

Pre-emption rights on the issue of new shares (or rights to acquire shares) are now restricted to Investors or Major Investors only. This makes it easier for companies to raise further funds from its existing key investors or third parties as it prevents smaller shareholders from either taking up capacity in a round (which is less of a problem in the current market) or having to be approached to waive their rights.

Similarly, the introduction of new investors often requires amendments to the Articles, which previously needed the approval of holders of at least 75% of the voting shares in issue, regardless of the investment round having already been approved by a lower, or at least different, threshold under the list of consent matters in the Shareholders’ Agreement.  This approval process was onerous and made it difficult to agree financings, particularly as companies grew and cap tables became larger and more diverse.  A new clause in the model Shareholders’ Agreement now states that, provided the requisite approval to the financing has been obtained under the consent matters (plus the approval of X% of shareholders (being such percentage (if any) as the parties may choose)), shareholders must irrevocably agree to any consequential (and non-discriminatory) changes to the Articles.

Both changes are allowing companies to implement top-up rounds much more efficiently.

7. Caution regarding automatic conversion of shares

The new model Articles need to be reviewed in light of the recent Court of Appeal decision in DnaNudge Limited -v- Ventura Capital GP Limited in October 2023, where it was held that the automatic conversion of preference shares into ordinary shares was void and of no effect and instead required additional class consent of the affected preference shareholders.

Whilst the new model Articles make it easier for share rights to be amended by now only needing the written consent of the holders of a majority of the class, rather than 75% of the shares of that class in issue, this additional hurdle can be avoided with careful drafting.  Provisions dealing with the automatic conversion of preference to ordinary shares and possibly also leaver’s shares to deferred shares need to be drafted in light of this decision.

8. Anti-dilution

The anti-dilution rights which allow certain investors to maintain their same ownership stake following a down-round were amended in the model Articles.  The formula to determine the number of compensatory top-up shares to be issued to those existing investors now takes into account the “weighted average” equivalent price per share on the subsequent down-round(s), rather than the lowest price, providing a more accurate calculation of the issue price, especially where there are multiple rounds of shares being issued at different prices.  However, we have seen VC investors being wedded to their original house-style on this and maintaining their more advantageous original position of using a “lowest price” calculation.

9. Bad Leaver

Previously, a Bad Leaver could lose their shares based on a vesting schedule (with the number decreasing over time).  A Bad Leaver now loses all of their shares with no sliding scale.  However, the definition of Bad Leaver was amended to capture only genuinely harmful matters to the Company – adding a new Bad Leaver event of where someone commits a material breach of any non-compete obligations owed to the Company (even if this was not the reason for, or happens after, their departure).  In our recent experience, investors have sometimes been adapting the model Articles to refer to any breach of any of their restrictive covenants, which would have the effect of (i) a minor breach and/or (ii) a breach of the related confidentiality or other ancillary clauses in the restrictive covenants (rather than the key non-solicitation obligation) triggering the disproportionately punitive consequence of losing all the Founder’s shares.  Such amendments should be strongly resisted by Founders in line with the BVCA position, together with considering adding that the material breach needs to also be deliberate and/or persistent.

10. Information rights

As a general principle, the BVCA amendments saw a number of the transfer-related rights now being granted to Major Investors only, such as on a co-sale.  Similarly, in line with this approach, information rights under the Shareholders’ Agreement have been limited to Major Investors too.  It is this latter restriction which has been particularly welcomed by Founders, who are keen to achieve the minimum administrative burden but also avoid the risk of confidential information falling into the hands of minority shareholders who may have competing interests. Whilst the BVCA documents include appropriate confidentiality obligations on all shareholders, there is no specific carve out from having to provide regular business updates to investors if they do compete, which companies may wish to consider adding depending on the profile of their investor base. Minority investors frequently negotiate to receive (and indeed Founders in practice like to provide) some form of regular financial and/or commercial  information to all shareholders, often in the form of quarterly shareholder update emails, which they may wish to either (i) keep optional by limiting information rights to Major Investors, or (ii) be able to restrict where there is potential competition. – either case ensuring that prevention is better than the cure when it comes to seeking to specifically enforce confidentiality restrictions.