Key terms of the Investment Agreement

Parties

Existing shareholders and the company

All the existing shareholders (and in particular the founders) and the company should be a party to the agreement, although it may not be practical for all minority shareholders to be a party if there are a large number of them.

Investors

Paper As the investment agreement deals with the subscription for shares by the investors in return for the investment monies, the investment agreement should bind all investors participating, including any separate funds that are investing.

Future shareholders

It is usual to have a provision requiring any transferee or new allottee of shares to enter into a deed of adherence which has the effect of treating the new shareholder as if he were an original party to the investment agreement and therefore bound by the provisions of the agreement. There is often a discretion for the board to waive this requirement and an exclusion for those exercising options.

Tranche payments

It is common in investments in life sciences companies for payments to be tranched, each such tranche being measured against the achievement of agreed milestones. Usually these milestones are measured against, for instance, the different stages of development of one or more products, the company agreeing to take on new developments or the results of pre-clinical or clinical trials. It is common for the investors to be able to waive milestones or other completion conditions in the event that these are not achieved.

Completion conditions – initial tranche

The investors will stipulate that certain conditions must be satisfied before the initial tranche of the investment can proceed to completion. These conditions may include the following:

completion of any necessary due diligence in respect of the company;
the delivery of a satisfactory business plan and management accounts;
obtaining any required tax clearances;
having the necessary authorities (board and shareholder) in place to issue the new shares to investors as part of the investment and adopting the new articles of association. This will likely require the passing of shareholder resolutions (whether by written resolution or by the holding of a general meeting) which may impact when the investment can be completed, depending how quickly these resolutions can be passed;
the founders and key management having being issued shares or options;
the assignment in full of necessary intellectual property rights owned by the founders or other persons to the company; and
appropriate insurance, such as keyman and directors' and officers' liability insurance, being put in place.

Initial tranche completion mechanics

These are the actions that need to be taken on the completion of the initial tranche of investment:

approval of the investment agreement and if applicable disclosure letter;
issue of subscription shares and related certificates to the investors;
appointment of the investor director(s) to the board of directors;
an obligation on the investors to pay the subscription monies to the company's bank account;
approval and execution of service agreements if the founders are to become executive directors of the company; and
adoption of or commitment to adopt a share option plan.

The investment agreement will stipulate that the proceeds of the investment (whether on the initial or subsequent tranches) must be used for achieving the agreed milestones and the realisation of the agreed business plan or budget.

Completion conditions – subsequent tranches

It is typical for completion conditions to be attached to each subsequent tranche of investment. These would commonly include:

completion of the initial investment/previous tranche occurring;
no material adverse change occurring (i.e. a negative event which impacts significantly on the business the result of which may otherwise effect an investor's willingness to invest in a company);
the achievement of the agreed milestones related to the tranche in question;
there being no material breach of the investment agreement, the new articles of association or a director's service agreement;
the continuing employment by the company of the founders/certain key employees; and
the company not having entered into an insolvency event.

Subsequent tranche completion mechanics

These are the actions that need to be taken on the completion of the subsequent tranches of investment:

issue of new shares and related certificates to the investors; and
an obligation on the investors to pay the subscription monies to the company's bank accounts.

Warranties

Calender Warranties are representations made by the warrantors, who are usually the founders and the company, that certain statements relating to the company are true and accurate at the completion date. Although the investors will have carried out due diligence on the company and pursuant to common law would have a right to sue the founders for misrepresentation if information provided was inaccurate, the investors will prefer such statements to be expressly included in the contract.

The warranties are given at completion of an initial tranche and sometimes on the completion of subsequent tranches. If prior to completion of a tranche, any of the warranties given by the warrantors are in fact untrue, this gives the investors a right in contract to sue the warrantors for breach of warranty. The warrantors can qualify the warranties by way of a disclosure letter and agree in the investment agreement any limitations to the warranties (for example, time limitations, materiality threshold and financial limitations on a claim (which, for a founder is usually linked to a multiple of his salary and for the company, is usually the full value of the investment)).

If the investment is in a start-up life sciences company, save for the IP warranties, the remaining warranties will be fairly limited in their application due to the company's limited trading history. IP warranties in life sciences investments, whatever the stage of the company, are more often than not more detailed and larger in scope than other warranties, due to the value, scope and complexity of the IP that they own or products that they are aiming to create and/or develop. Warranties will likely be even more extensive if a life sciences company is going through a second or later round of investment.

Other examples of typical warranties include the following:

business plan;
shares and constitution of the company;
liabilities and contracts;
directors and employees; and
tax (particular for life sciences companies that are not involved in their first round of investment).

Investor consent regime

The investors will usually have a minority interest, i.e. they will together be holding less than 50% of shares in the company on completion of an initial investment. However, historically it is not uncommon for investors in life sciences companies to quickly hold a majority interest, particularly if the company requires more than one round of investment, due to the size of each investment and the amount of money that is often needed to develop a life sciences company's product(s). Under English company law, many shareholder matters can be passed by either a majority of shareholders or by at least 75% of shareholders.

The investors will want a contractual right to prevent shareholders taking key decisions without their consent. This applies to management decisions as well as shareholder decisions, such as:

varying the rights attaching to the shares;
the issuing or granting of options over the company's securities;
adopting new articles of association;
removing or appointing a director;
making a material change in the nature of the business of the company;
acquiring any shares or other securities;
making any changes in the service agreements;
entering into unbudgeted capital expenditure exceeding a certain amount;
entering into any litigation;
incorporating a new subsidiary; and
disposing of any assets (in particular IP) of the company other than in the ordinary course of business.

The level of consent is very much dependent on how many investors are investing in the company. If there is only one investor, then it is usual to state that none of the matters listed above can be taken without the prior approval of that investor. However, where there is a consortium of investors it is impracticable and time consuming to require the consent of every single investor before any shareholder matter or board matter is undertaken. In these circumstances it is much more usual to require the consent of the investors together holding a certain percentage of shares (which are usually preferred shares – see below) held by the investors.

Financial information

Finance It is often a requirement that, when they bring an institutional investor on board, management have to produce management accounts, audited accounts and financial models and budgets for the upcoming financial years which they have to deliver to investors prior to certain dates. This can be burdensome for management to produce. In addition, the investors are likely to require that they can access on request the accounts of the company for inspection.

Board representation

In most cases investors in life sciences companies are likely to require that they are able to have an entrenched right to appoint a director and that a majority, if not all, of the directors appointed by the investors need to be present in order for there to be a quorum of any meeting of the board to allow business to proceed. An investor director can contribute his know how and expertise in the industry. Founders may also have an entrenched right to appoint a director. In some cases, investors may look for `observer rights' so that they have the right to send non-directors to sit in and observe board meetings and to receive board papers, but not to vote. Whilst board representation is to be expected, it can prove unwieldy if a company has gone through several rounds of investment with new institutions collecting new board members at each round.

There are rules under company law with regard to conflicts of interest of directors and the investor director will need to declare any of his interests in the investor he represents such as being entitled to a bonus or carried interest if the fund is successful or directorships in competing companies which the board can then authorise.

Restrictive covenants

The purpose of restrictive covenants or non-competes is to prevent the founders from competing with the business of the company whilst, and when they cease to be, involved with the company. Typically, restrictive covenants will be found in the service agreement as well as the investment agreement. However, restrictive covenants in the investment agreement are generally more enforceable than those in the service agreement, as the founders are giving the covenants as shareholders (not employees) in part consideration for the investment.

Exit

There may be a provision in the investment agreement which states the parties' intention to work towards an exit, for example a listing of the company on a recognised stock exchange or a sale of the company, within a specified period of time (usually 3 to 5 years). Coupled with that intention is generally an acknowledgement that an investor will not give any warranties or indemnities regarding the business and affairs of the company on an exit, other than warranties relating to its capacity to sell its shares.

Confidentiality

There will be a provision in the agreement to ensure that its parties will keep all confidential information confidential. Normally, an investor is expressly allowed to disclose information to its employees, members, participants etc.

Costs

The company usually pays for the investors' reasonable legal and due diligence fees or a proportion of such fees as well as its own costs and sometimes those of the founders.

Other matters to note

test tubes Certain investors in life sciences companies may require the company and the founders to enter into specific undertakings or requirements as part of their investment, particularly if they are charitable entities or have a particular social focus or aim. These will need to be considered carefully when negotiating the term sheet and the definitive legal documents as a breach of them can often have serious consequences for both an investor and the company e.g. for instance a need for that investor to sell its shares or to not provide further funds in subsequent tranches of investment.