practical law drafting notes to bvca subscription and shareholders' agreement for early stage

88 Pages·2017·1.19 MB·English

PRACTICAL LAW DRAFTING NOTES TO
BVCA SUBSCRIPTION AND SHAREHOLDERS'
AGREEMENT FOR EARLY STAGE
INVESTMENTS

Last reviewed November 2017, unless otherwise stated

The commentary contained in these drafting notes may be used as a guide
for drafting only and does not constitute legal advice
DRAFTING NOTES TO ACCOMPANY THE BVCA SUBSCRIPTION AND
SHAREHOLDERS' AGREEMENT FOR EARLY STAGE INVESTMENTS

General document notes
The two principal documents involved in a venture capital investment will be:
 A subscription and shareholders' agreement, also known as an investment agreement.
This will often be a single document, although it may be split into two separate
documents, a subscription agreement and a shareholder or investor rights agreement.
 New articles of association of the company in which the investment is being made. The
articles form part of the company's constitution and govern the internal management of
the company's affairs. The articles are subject to the requirements of the Companies
Act 2006 (CA 2006). For more information, see BVCA Articles, Drafting note, General
document notes.
In these drafting notes:
 The BVCA industry standard articles of association and subscription and shareholders'
agreement are referred to as the Articles and the SSA, respectively.
 The company in which the investment is being made is referred to as the Company.
Unless provided otherwise, capitalised terms used in these drafting notes have the same
meaning as given to them in the Articles.
These drafting notes are based on the form of SSA published on the BVCA website in October
2014 and so do not take account of changes made to the SSA after that date. Users of the
Articles and the SSA should satisfy themselves that the provisions of those documents reflect
the current law and are suitable for purpose. Unless otherwise indicated, these drafting notes
are up to date as at November 2017.
Please note that drafting notes relating to data protection issues have not been reviewed since
September 2016. Also, UK data protection law will change on 25 May 2018, when the EU
General Data Protection Regulation (GDPR) takes effect, replacing the Data Protection Act
1998 (see EU General Data Protection Regulation toolkit for information on the new
Regulation). These drafting notes do not take account of the need to comply with the GDPR
from May 2018.
What is a subscription and shareholders' agreement?
The subscription and shareholders' agreement will, unless issues have arisen during the due
diligence exercise, reflect the provisions of the term sheet. Unlike the term sheet, all of the
provisions of a subscription and shareholders' agreement are intended to be legally binding.
The subscription and shareholders' agreement will usually be made between:
 The investors.
 The management of the company (and, possibly, other existing shareholders, such as
employees).
 The company.
It records the commercial terms of the arrangement between the parties and will include
specific details of the investment round (or rounds), including the number and class of shares
to be subscribed for by the investors, payment terms and warranties about the condition of the
company.
The warranties will be qualified by the terms of a disclosure letter (or letters if there are a
series of investment rounds) which will refer to supporting documents (usually referred to as a
"disclosure bundle") and will specifically set out any issues that the management and the
company think the investors should know of, prior to completion of the investment.
One agreement or two?
Early stage companies seeking venture capital investment may undertake a number of funding
rounds over a period of years. For example, a life sciences start-up seeking to develop a
compound for clinical testing will often require an injection of cash at each stage of
development. In those circumstances, it will be appropriate to consider whether the investors
should enter into a single subscription and shareholders' agreement which sets out both the
investment mechanics and the provisions regulating their ongoing participation in the company
as shareholders, or whether the subscription agreement should be a separate document from
the shareholders' agreement.
A separate subscription agreement should mean that, on each subsequent funding round, the
incoming investors need only negotiate and execute a short document setting out the
mechanics and terms of their subscription, including any warranties from the company and
management team. Each subscription agreement would be a standalone document,
unaffected by any other.
The approach described above ought then to allow for a single shareholders' agreement (also
known as an investor rights agreement), setting out the investors' rights. On each funding
round, any new incoming investor should adhere to that agreement alongside the existing
investors (although some changes may be required to reflect the term sheet of any new
investment round). As well as reducing the amount of documentation required on each funding
round, a uniform set of rights for investors should more easily allow the investors to monitor
management's compliance with the provisions set out in that agreement. This approach is
common to US venture capital transactions.
Should provisions be included in the SSA or the Articles?
The parties should consider which provisions should be included in the SSA and which should
be in the articles of association. The SSA binds only the parties to it; the articles of association
bind all of the company's shareholders and the company.
However, it is common for a subscription and shareholders' agreement to include a provision
stating that, in the event of conflict between the articles and the subscription and shareholders'
agreement, the terms of the subscription and shareholders' agreement shall prevail (for an
example, see clause 27 of the SSA).
Generally, a subscription and shareholders' agreement will also contain provisions protecting
the investors' interests. In addition to the warranties referred to above, these protections
include rights to board representation, information rights, consent rights and non-compete
restrictions (see respectively, clauses 8, 9, 10 and 14 of the SSA).
The articles of association will include details of the rights attached to the different classes of
shares, the procedure for the issue and transfer of shares and the procedure for holding
shareholder and board meetings.
Drafting assumptions

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The SSA assumes that:
 The Company is a private company limited by shares registered in England and Wales.
 If the Company has any subsidiaries, each of them is a private company limited by
shares registered in England and Wales.
 Before completion of the investment, the Company's share capital is made up of
ordinary shares only.
 This will be the Company's first round of venture capital investment.
 The investment will be made by one or more venture capital investors.
 The Investors' obligation to invest will be conditional and will require the Company and
the Founders to give a full set of Warranties to the Investors.
 Each Investor will subscribe for a preferred class of Series A Shares. No other shares
will be issued at completion.
 The investment may be made in more than one tranche.
 No Investor will subscribe for preference (non-equity) shares or loan notes in the
Company.
 The transaction will not involve any third party lending at completion.
 There will be no delay between exchange and completion, which will occur
simultaneously.
 US securities laws or ERISA provisions are not to be included. The SSA includes
sample provisions in Appendix B to the SSA. For notes on those sample provisions,
see Drafting note, Appendix B: US securities law requirements and ERISA.
Simple contract or deed
The SSA provides alternative execution blocks that would allow this agreement to be executed
under hand as a simple contract, or as a deed.
A shareholders' agreement will often be executed as a deed, for two main reasons:
 To avoid concerns about whether or not consideration is provided to the managers for
their obligations under the agreement, in particular the restrictive covenants that they
will be asked to give under clause 14.
 As a power of attorney must be executed as a deed under section 1 of the Powers of
Attorney Act 1971. Paragraph 16 of schedule 7 to the SSA contains a power of
attorney given by the Founders in relation to the signing of elections pursuant to
section 431(1) of ITEPA 2003.
It is also considered that the use of a deed extends the limitation period from 6 years to 12
years. This is a subsidiary reason to those set out above and the BVCA Legal and Technical
Committee considers that this advantage is not, on its own, of sufficient significance in the
context of the SSA to necessitate the SSA being in the form of a deed.
Execution of the SSA under hand as a simple contract would alleviate the inherent difficulties
of executing a document as a deed. The required power of attorney found in paragraph 16 of

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schedule 7 to the SSA could instead be given by way of a separate deed, deliverable at
completion.
In light of the potential issue relating to the adequacy of consideration given to the Founders
for their undertakings and obligations under the SSA, the BVCA Venture Committee and Legal
& Technical Committee sought Counsel's opinion on the validity of the agreement if executed
under hand. Counsel's opinion, delivered on 14 September 2014, is available on the BVCA's
website and the question of execution of this SSA should be considered in light of that opinion.
If the SSA is to include termination of a Prior Agreement (see clause 22.2) and that Prior
Agreement was executed as a deed, this SSA ought also to be executed as a deed (see
Drafting note, Clause 22.2: Prior Agreements).
If the SSA is to be executed as a deed, delete clause 30 (and renumber the rest of the
agreement as appropriate). If it is to be signed under hand, clause 30 should be included and
the power of attorney provision must be removed from paragraph 16 of schedule 7.
There are an increasing number of instances where the parties to a transaction wish to
execute documents electronically, including through web or app-based signature platforms. To
assist in this regard, a joint working party (JWP) of The Law Society Company Law Committee
and The City of London Law Society Company Law and Financial Law Committees has
published guidance on the use of electronic signatures in commercial contracts.
For more on execution generally, see Practice note, Execution of deeds and documents.
Parties
This part of the agreement identifies the parties to the agreement.
The document assumes that the investment will be made by a number of investors
participating in a syndicated investment. If the investment is syndicated, consider whether to
appoint a lead investor to take charge of negotiating the terms of the investment.
If a lead investor is appointed, consider on what basis it is to be appointed and whether it,
(rather than a majority of the investors, as in the SSA (see Drafting note, Clause 1: Investor
Majority) should have the ability to take other key decisions under the agreement, (such as
when to bring claims under the Warranties).
If the investment is not syndicated, amend the parties clause by inserting the investor's details
and delete Part 1 of schedule 1 to the SSA. Consequential amendments will also be required
throughout the document. For example, the definition of "Investor Majority" in clause 1 will not
be necessary. In such circumstances, consider whether some or all of the decisions reserved
to an Investor Majority should require the sole investor's approval instead.
The Founders are listed in Part 2 of schedule 1 to the SSA. They are likely to include the
Company's Founders and some (or all) of the Company's directors.
The SSA also includes optional provisions allowing other Shareholders to be parties to the
agreement. Whether the Investors require those other Shareholders, if any, to sign up to the
restrictions and obligations imposed by the SSA will depend on, among other things, the
proportion of voting rights held by each of them and their importance to the business of the
Company (or the wider group of companies). Investors may insist on all Shareholders being
parties to the SSA to provide comfort that all Shareholders have accepted the preferential
rights granted to the Investors. The Investors may consider that such acceptance may make it
more difficult for a disgruntled Shareholder to claim that he has been unfairly prejudiced by the
investment and the Investors' associated preferential rights.

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If all Shareholders are to be parties to the agreement, it may be more administratively difficult
to vary the terms of the SSA if such a variation would require the consent of all the parties. In
that case, the Investors may seek a variation clause on terms as set out in clause 23, under
which a specified percentage of the Shareholders may bind all Shareholders to a variation
(see Drafting note, Clause 23.1: Variation).
Introduction
This section, sometimes called the recitals, briefly describes the background and purpose of
the agreement. It can be a useful point to introduce any unusual or complicated features of the
agreement, which can be defined and then picked up later in the agreement.
As a matter of general construction, this part of the agreement does not form part of the
operative provisions. It does not have direct legal consequences, although in cases of dispute,
it may be used as an interpretative guide to operative provisions which are subsequently found
to be obscure or ambiguous in meaning or otherwise the subject of dispute.
Clause 1: Definitions
The main purpose of a definitions clause is to reduce repetition within the body of the SSA,
making the document shorter and easier to read. It also gives specific meanings to particular
words used. This avoids ambiguity and also makes clear that the term is intended to include
matters which it might not otherwise be found to include (or vice versa). The definitions and
rules of interpretation in clause 2 apply to the whole of the document.
Drafting issues
 Care should be taken with definitions, as the construction of key parts of the SSA may
depend upon them.
 Be consistent: where a capitalised term is used, don't introduce it without capitals
elsewhere in the document, or use a different form of words to mean the same thing.
 Examine each definition carefully to make sure it means what you intend it to mean,
and where necessary, change the drafting to reflect the intention of the parties.
 Where a defined term is likely to be used in a particular clause, schedule or paragraph
only, it may be preferable to include the definition at the beginning of the relevant
clause, schedule or paragraph (for example, see the definition of "Confidential
information" in clause 15.3). This approach can be particularly useful where the
definition relates to a specialist area, and the contractual provisions relating to that
area will be negotiated separately by practitioners in that field.
 If a term is defined in the body of the agreement, but used in multiple clauses, it may
be helpful to include a cross reference in clause 2 to the clause containing the relevant
definition.
 The CA 2006 and other statutes contain a number of definitions that may be useful to
incorporate in the agreement by reference. However, it is generally unwise to include a
provision incorporating all definitions used in all acts, since some of these may be
wider than the parties realise (for example, "director"). A risk in using terms as defined
by statute (and not by the parties) is that the courts may interpret the statutory
definition in a manner which may have unexpected or even adverse consequences in
an agreement.
For further information on interpretation generally, see:
 Standard clause, Interpretation and the related drafting notes.

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 Practice note, Contracts: interpretation.
Clause 1: Adequate Procedures
This term is used in paragraph 10 of schedule 7, which sets out the undertaking from the
Founders and the Company that the Company has and will maintain in place Adequate
Procedures designed to prevent any Associated Person from undertaking any conduct that
would give rise to an offence under section 7 of the Bribery Act 2010.
Section 7 of the Bribery Act does not define "adequate procedures" but section 9 of the Bribery
Act requires the Secretary of State to publish guidance on the procedures that companies can
put in place to prevent bribery by their associated persons. The Ministry of Justice published
adequate procedures guidance on 30 March 2011. For more information, see Practice note,
Bribery Act 2010: anti-corruption policies.
Clause 1: Additional New Shares
See Drafting note, Clause 3.3: Additional New Shares.
Clause 1: Business
This definition explains the current business of the Company. It is principally used in relation to
the business undertakings of clause 11 and in certain Warranties. In particular:
 The warranty at paragraph 2.3 of Part 1 to schedule 5 states that the Warrantors are
not aware of any information not Disclosed that is relevant to the Business.
 Under paragraph 3 of Part 2 to schedule 6, the Founders and the Company undertake
not to make any change to the nature of the Business without Investor Director
Consent.
As such, it will be important to carefully consider the definition to ensure that it accurately
reflects the nature of the Company's business at the point of Completion.
Given the effect of clause 2.15, if the Company forms part of a wider group, it may be
necessary to adapt the definition of "Business" to encompass the business of those other
Group Companies (see Drafting note, Clause 2.15: References to the Company).
Clause 1: Claim
This term only relates to claims made under the Warranties. Under clause 22.5, the only
available remedy for a Claim is an action for damages. For any other claim under this
agreement, the remedies of injunction or specific performance may also be available. The
Investors should consider whether to extend this definition to cover any other claim under the
agreement.
Clause 1: Company Website
See Drafting note, Warranty 10.14: Company website.
Clause 1: Completion
In the context of a venture capital investment, completion is the point at which the Investors
release their subscription monies to the Company and the Company issues the Series A
Shares to the Investors.
As Completion cannot occur until all of the Completion Conditions have been satisfied or
waived, Completion need not take place on the same date as the SSA is signed (also known

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as "exchange"). This may be the case where, for example, completion of the investment is
subject to regulatory or third party consents. For considerations relevant to a split exchange
and completion, see Drafting note, Clause 4: Completion.
In most venture capital investments, however, the Investors will wait until all Completion
Conditions are capable of being satisfied before dating the agreement, allowing exchange and
Completion to occur simultaneously.
Clause 1: Computer System
See:
 Drafting note, Warranty 10.18: Third party and shared IT assets and computer data.
 Drafting note, Warranty 10.19: Computer System.
 Drafting note, Warranty 10.20: Disaster recovery.
Clause 1: Data Protection Legislation and Data Protection Principles
See Drafting note, Warranty 14.6: Data protection.
Clause 1: Deed of Adherence
If any person who is not already a party to this agreement acquires shares through allotment
or transfer, he will be required to execute a deed under which he agrees to adhere to and
observe the terms of the SSA. In particular, see clause 3.3, and clauses 13.2 and 13.3. For
more information, see Drafting note, Clause 13.2: Deed of Adherence.
Clause 1: Disclosed
Disclosure is the process by which the Company and the other Warrantors make general and
specific disclosures against the Warranties given in clause 5 and set out in schedule 5. If the
Warrantors fail to disclose a relevant matter in respect of the Warranties they may be sued by
the Investors for breach of Warranty. The Warrantors usually make their disclosures in a
disclosure letter and attach relevant documents to that letter to support their disclosures (the
disclosure bundle).
The meaning given to this term is important as it sets the standard to which disclosure must be
made in order for the disclosure to be effective in qualifying a Warranty. The question of what
constitutes "fairly disclosed" has been considered in a number of cases, and most recently in
Infiniteland Limited and another v Artisan Contracting Ltd and Artisan (UK) PLC [2005] EWCA
Civ 758 and MAN Nutzfahrzeuge AG and others v Freightliner Limited [2005] EWHC 2347,
which indicated that the courts may be prepared to look to the strict drafting of an agreement in
assessing the adequacy of disclosure. In light of these cases, Investors should not assume
that there is an overriding requirement for a disclosure to be full, clear and accurate to be
effective in qualifying a Warranty, unless additional wording is expressly included. The
definition in the SSA provides that a disclosure must be fair (but not full, clear and accurate)
and include sufficient detail and explanation to clearly identify the nature, scope and full
implications of the matters disclosed.
If the investment is made in more than one tranche, include the reference to the Further
Disclosure Letter.
For further information relating to the standard of disclosure, see Practice note, Disclosure:
acquisitions: How full and complete must disclosure be? and When is a disclosure fair?
Clause 1: Disclosure Letter

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The disclosure letter is given by the Company and the other Warrantors to the Investors. It
sets out qualifications to the Warranties set out in Part 1 of schedule 5 to the SSA.
In the majority of venture capital transactions, the disclosure letter is addressed from the
Warrantors to the Investors. In some circumstances, it may be more convenient for the letter to
be written on the Warrantors' behalf by their solicitors (for example where there are a large
number of individual Warrantors), but this approach is rare in practice.
The disclosure letter will usually have a bundle of documents attached to it, which contains
copies of all documentation that is being disclosed. This bundle is referred to as the disclosure
bundle.
If exchange of agreements and completion of the transaction will take place simultaneously, it
is not strictly necessary to refer to the Disclosure Letter as being in the "agreed form" as, in
practice, neither party will proceed to Completion unless they are happy with the form and
content of the letter. However, it may assist in managing the transaction and the document
production process to specifically refer to the Disclosure Letter as being in "agreed form".
For a sample disclosure letter, see Standard document, Disclosure letter: non-leveraged
investments.
Clause 1: Encumbrance
This term can be widely construed, and may include many kinds of restriction on a person's
ability to deal freely with shares or assets in their ownership or control.
Always consider the context in which the term is used, particularly where any Warranties or
representations are given that shares or assets are "free from encumbrances"; for example,
see paragraphs 9.3, 10.18 and 11.3 of Part 1 to schedule 5.
Paragraph 10 of Part 2 to schedule 6 restricts the Company's ability to create any
Encumbrance over any of its assets without Investor Director Consent.
Clause 1: ERISA
See Drafting note, clause 38: ERISA.
Clause 1: First Tranche Shares
Include this definition if the Investors' subscription for Series A Shares is to be split into two
tranches. If there is only one round of investment, delete this definition and amend the
definition of New Shares as appropriate.
Clause 1: Further Disclosure Letter
This term will only be required if the investment is to be made in two tranches. If the
investment is to be made in a single tranche at Completion, delete this definition.
Clause 1: Further Relevant Change Letter
See Drafting note, Confirmation of relevant change to PSC register on Completion.
Clause 1: Grant Funding
This term is only used in warranty 14.7 of Part 1 to schedule 5.
Clause 1: Group Companies

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Although the Company may not be a member of a corporate group at the time the SSA is
entered into, it would be prudent to retain Group Company references in the SSA to cater for
possible future corporate structure changes.
In the SSA, the Subsidiaries include each entity that is a subsidiary of the Company within the
meaning of section 1159 of the CA 2006. At Completion, this should only comprise those
whose details are set out in Part 2 of schedule 2 and any other company that is, for the time
being, a subsidiary within the meaning of section 1159 of the CA 2006.
Clause 1: Intellectual Property
For a discussion of the drafting of such a definition, see Standard clause, Definition of
intellectual property rights and the related drafting notes.
Clause 1: Investor Director Consent
Typically, Investors will expressly set out those matters that a company or its directors cannot
undertake without consent. Often those matters will be split between those that require
consent from the Investors themselves (see Drafting note, Clause 1: Investor Majority
Consent) and those that require the consent of Investor Directors appointed by the Investors
(see Drafting note, Clause 1: Investor Directors). One of the reasons for drawing a distinction
between Investor Majority Consent and Investor Director Consent matters is because an
Investor Director has a duty to act in the best interests of the shareholders as a whole (see
Drafting note, Clause 8.2: Investor Directors and observers). Accordingly these wider
considerations may fetter his or her discretion in circumstances where they would not fetter the
discretion of an Investor Majority.
For those matters reserved for the Investor Directors, this agreement provides alternatives for
how Investor Director Consent may be obtained by the Company. Consent must either be
obtained from all Investor Directors or a specified number of them, according to the drafting.
Where there are (or the SSA allows for) more than two Investor Directors in office appointed
by different Investors, the Company ought to request something less than unanimity for greater
ease of administration.
Clause 1: Investor Directors
At and from Completion, each Investor has the right to appoint a director to the Board,
provided it holds a minimum percentage of the Equity Shares. Alternatively, the SSA may vest
the right to appoint Investor Directors in the Investor Majority. For more information, see
Drafting note Clause 8.2: Investor Directors and observers.
Clause 1: Investor Majority
Typically, Investors will expressly set out those matters that a company or its directors cannot
undertake without consent. Often those matters will be split between those that require
consent from the Investors themselves and those that require the consent of Investor Directors
appointed by the Investors (see Drafting note, Clause 1: Investor Director Consent). However,
where there are multiple Investors, the process of obtaining consent from each of them may
take time, leading to delay in matters which may require the Board to act quickly.
As a result, a syndicate of Investors will often agree between themselves that a defined group
of Investors may give consent on behalf of all Investors. That group is usually defined by
reference to Investors together holding a minimum percentage of all Shares held by Investors.
The precise percentage will be agreed on a case-by-case basis, according to the relative
holding of each Investor. That percentage threshold will usually be determined exclusively
between the Investors, according to the relative holdings of Series A Shares held by each of
them.

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