One major reason businesses seek investment is to drive growth. With cash landed from investors, you can scale operations, enter new markets, develop new products, and hire top talent. But how to ask investors for money? Simply put, just ask. But you need to know how to present your ‘ask’ correctly—that is, knowing which investor documents are there and how to craft them effectively so that investors agree to write you a check.
Fundraising is tough. You’re constantly jumping from one investor to another, convincing them to fund you. The investment process itself is even more complicated. What are the specific terms and conditions of the investment? How will this investment affect the ownership structure? How much ownership should an investor get? Have you given all the necessary information? These and even more questions are what may keep founders awake at night.
To sleep well at night and not worry that you may make a costly mistake or agree on worse terms, you must know which investor documents are involved at each stage, from an initial meeting to post-investment management. In this article, we’re going to walk you through essential fundraising documents, their purpose, and the role each plays in raising money.
Term sheet and its key components
A term sheet is a non-binding (except for confidentiality and exclusivity) investment legal document that outlines how the relationship between an investor and an entrepreneur will work. It opens the door for more detailed negotiations, serving as a great tool for creating FOMO.
The key components of a term sheet:
- Company’s valuation and investment amount: Valuation determines how much of your company you’re going to exchange for the amount of money investors will give you. This investor document includes pre-money valuation (the value of your business before fundraising), post-money valuation (the value of your business after fundraising), and the total investment amount.
For example: A VC says that your company is worth $10 million, and they’re going to write you a $5-million check. It means that your pre-money valuation is $10 million, your post-money valuation is $15 million, and you’ve just sold a third of your company for $5 million.
What you’re actually selling: It’s important to specify the type of equity being issued—common stock, preferred stock, or convertible notes. Typically, VCs don’t invest in debt, so you’ll be selling equity—more specifically, preferred equity. Why? Because it allows venture capitalists certain rights and privileges, such as liquidation preferences and anti-dilution protections.
Liquidation preference: This part of an investor document presents downside protection, allowing VCs to get back their investment before anyone else gets any money.
Getting back to the previous example: Let’s imagine that you’ve found a buyer for your company for $5 million. A liquidation preference allows the VCs to get their $5 million investment back first. If you sell your company for $8 million, they would get their $5 million, and you would get the remaining $3 million. But if you sell your company for $3 million, VCs would actually lose money on that deal, and they would take only $3 million back.
- Voting rights and board composition: VCs are able to put in different voting rights. They may want a board seat or the ability to influence your future fundraising efforts, sales, and onboarding processes.
Tip: Taking control over your company isn’t what most VCs are targeting. They want to protect their investment and help you build a successful business because that’s the only way for you both to make money.
Anti-dilution provisions: This part of an investor document protects investors from losing their ownership percentage in future funding rounds. If a company sells shares at a lower price than before, these provisions help investors maintain their stake.
Conditions precedent: A part of an investment document that lists the requirements a company must meet before the investment is finalized, including due diligence, regulatory approvals, etc.
Once you agree on the term sheet, the next step is signing the formal investment agreement — the legally binding contract that finalizes the deal.
Shareholders’ agreement
A shareholders’ agreement is a long-term investment document that commands the relationships between all the company’s shareholders. Think of it as a marriage contract—an agreement between interested parties listing all their rights and responsibilities for life (for the life of the company, in our case).
The purpose of these fund documents is to prevent disputes in the future and to outline how to resolve any that arise. If you don’t sign a shareholders’ agreement at the start while everyone is on a “honeymoon stage,” it will be much harder to settle conflicts later on.
You need to consider all possible long-term scenarios in advance. This includes knowing what to do if someone wants to leave, sell their shares to a third party, or if something unexpected happens. That’s how a shareholders’ agreement works.
Key provisions:
Rights to transfer shares: These are the guidelines on how and when shareholders can sell or transfer their shares. Also, if any restrictions or approvals are needed, it’s also stated here.
Protection for minority shareholders: This part of an investor document is about giving a ‘say right’ to smaller shareholders.
Governance and voting rights: It outlines how major business decisions are made, who gets to vote on them, and what kind of majority is needed for approval.
Cap Table
A capitalization table, or a cap table, is a startup document that shows how equity is distributed between the shareholders. A cap table typically includes information on shares, convertible notes, stock options, advisory shares, and warrants. When investors want to know how equity is diluted, which percentage is given to whom, or what the value is, they look at the company’s cap table. Put simply, a cap table is a record of who knows what.
A cap table is primarily an internal fundraising document that helps founders track vesting schedules, exercise dates, fair market values, and equity types. That’s why having a well-organized cap table is so important, and you better start structuring it as soon as you start your business. The more shareholders and funding rounds there are, the harder it becomes to track and keep everything in order.
For instance, you want to get another round but can’t do it without getting majority approval from your Series B, Series A, and seed shareholders. At this point, it’s already confusing as you must remember everyone who has participated. And now, imagine that you don’t have a well-organized cap table. How would you know whose approval you need?
Additionally, some investors may own different types of shares from multiple investments. How do voting rights work in this case? Or how would these investors get paid if the company is sold? But when you have a well-structured cap table, you can answer these questions easily.
Important aspects of a cap table:
Shareholders’ names and ownership percentages: These are the lists of all individual or institution shareholders and how much of the company they own.
Types of equity owned: This part of a startup document shows what kind of shares or securities each shareholder has.
Option pools and other dilutive effects: Here, it’s explained how options and other securities could dilute ownership in the future.
Subscription agreement
A subscription agreement controls how investors put capital into a company in exchange for its shares. This investment legal document is typically used when new company shares are being issued. It is a one-time agreement that is valid for a short period—when the money comes in and the shares go out.
From an investor’s perspective, the main concern is managing risks. They want to make sure the company is exactly what you described it to be. Since founders and key employees know the company best, investors expect this list of warranties to be accurate and true.
For entrepreneurs, the focus is on making the deal happen as planned. They evaluate all the conditions set by investors to ensure a successful fundraising process.
The main sections include:
Offer details: This part of an investor document explains what kind of shares are being issued and how many.
Investor commitments: Here, investors promise to adhere to the terms of this agreement.
Company assurances: These are guarantees from the company that everything is as they say and the shares are valid.
Unlike other investment legal documents, like a shareholders’ agreement or an investor rights agreement, which might not change across multiple funding rounds, a subscription agreement is used once per round to determine the terms for that specific investment.
Investor Rights Agreement
An investor rights agreement talks about the privileges and protections given to investors, particularly those with preferred stock. With this investor document investors know they are well-protected during and after they make an investment.
Key features of an investor rights agreement:
Information rights: Investors can check financial books, records, and other essential business data. Such checks help investors understand how the company is performing—whether it brings profit, how much, etc.
Pre-emptive rights: Investors are able to buy additional shares in the next funding rounds to maintain their ownership percentage. In such a way, they can prevent the dilution of their stake.
Registration rights: These rights make it easier for investors to list their shares for public trading and sell them in the market.
Due Diligence Documents
Due diligence documents are the collection of documents a startup must give to investors for a comprehensive check. These startup documents help verify the information business owners showed about the company in their pitch deck. During due diligence, investors, typically with the help of external experts, check your company’s business model, market position, operational stability, financials, and growth potential. Investors want to make sure that this investment is really worth the risks they take.
Many founders view due diligence as a negative check. But it’s meant to be positive. This deep dive allows investors to identify a company’s strengths and potential for future success. Of course, VCs are also looking for risks. However, at the end of the day, they invest in the potential to become a leader, as no startup is perfect in every aspect.
Due diligence documents include:
Financial statements and projections: These startup documents present a company’s past data and future expectations.
Legal compliance and patents: Here investors may check if a company follows the laws and knows the details of any patent or intellectual property.
Market analysis: Research that supports a company’s business model and market strategy.
More investor documents
There are two more startup documents that are worth mentioning. These are an investment teaser and a pitch deck. Although they aren’t considered formal investor documents, a fundraising process can’t go without them.
An investment teaser or one-pager is literally a one-page startup document that represents your company to potential investors. It’s sent to intrigue investors to get a meeting and share enough information so they get interested and want to know more about your business. Sending your teaser to investors is the first step to getting funding. For VC funds, the equivalent document is a tear sheet — a concise summary of fund performance and strategy used to attract LPs.
An investment teaser typically includes:
A company name;
Problem statement;
Solution;
Market opportunity;
Business model;
Major KPIs and traction;
Competitive edge;
Contacts.
A pitch deck is a multi-slide presentation, typically 10-20 slides, that gives a full view of your startup. This startup document is usually given to investors during an initial meeting and is created to walk investors through the critical aspects of your business in order to get a term sheet and arrive at raising capital.
A pitch deck consists of:
Title slide;
Problem;
Solution;
Market opportunity;
Product / technology;
Business model;
Go-to-market strategy;
Traction and milestones;
Competitive moat;
Financials;
Team;
Funding needs.
Final thoughts on investor documents and tips to secure investment
For startups looking for funding, understanding and preparing investor documents should be a meat-and-potatoes activity. Starting a business isn’t just about solving a problem for your target customers, it’s about the nitty-gritty stuff of actually running a business. And preparing investment documents is a part of this routine. When you know investor rights and expectations, it’s easier to establish a more beneficial relationship with no costly mistakes.
Hopefully, you now have a better understanding of critical investor documents and how they can be game-changers in landing the investment you want.
To increase your chances of securing the best deal, consider the following tips that helped our clients:
Keep your cap table up-to-date and well-organized. This will help you understand your ownership structure and prepare for future funding rounds.
Ensure that all the information you provide is accurate and clear. Transparency builds trust with investors.
Always have a legal expert review your investment documentation to avoid potential pitfalls.
Post-funding, maintain open and regular communication with your investors. This will help you build a strong, trusting relationship.
If you need any help with creating investor documents, contact our team. We have already helped more than 1K clients land $3+ billion in venture funds, and we know how to help you get the best deal possible.
FAQs
Why should potential investors and customers care about your business?
Potential customers care about your business because it may offer a solution to address their pain points. In the case of investors, they see your business through the prism of the value it brings to the customers, growth potential, and returns it may give to them in the long run.
What is an investment report that is given to potential investors called?
This report is called a prospectus. This investor document helps investors understand what’s being offered and gives details about the investment.