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The VC Series – Completion and Tranched Investments

‘The VC Series’ is a series of articles aimed at founders who are thinking of raising funds from VCs. Further information about The VC Series can be found here.

At its most straightforward, a VC will subscribe for its new shares and transfer subscription funds to the company immediately upon the signing of the necessary investment documents. However, transactions can include additional requirements such as conditions to completion or staged completions, where funds are drawn down in tranches, which can make completions more nuanced.

This article provides a brief overview of some of the completion structures you might encounter as a founder when seeking investment from VCs.

Exchange and Completion

When obtaining investment, the company will be required to enter into a form of subscription or investment agreement with the VC (and often other investors who are investing alongside the VC as part of the round). This agreement will deal with the subscription for shares by the investors in return for their investment.

‘Exchange’ of this agreement is the point at which it has been signed by the parties and is dated – this is the point at which the document will typically become legally binding.

‘Completion’ is the point at which, amongst other things, the VC will be legally obliged to subscribe for its new shares by transferring funds to the company.

Simultaneous Exchange and Completion

At its most simple, completion of the transaction will take place at the same time as exchange – this is sometimes referred to as a ‘simultaneous exchange and completion’.

However, even in these circumstances, the obligation of the VC to subscribe for its shares will be conditional upon certain completion formalities taking place. The most important of these will be the passing of all necessary director and shareholder resolutions and the adoption of new Articles of Association, however there may well also be others that the VC requires.

In practice though, under this arrangement these formalities will have been dealt with and agreed by the parties and their advisors at or prior to signing, meaning that there would be no discernible ‘gap’ between exchange and completion.

This approach is typically the one most favoured by founders, as it gives them certainty that the investment will be secured upon exchange of the agreement.

Conditions Precedent

Sometimes though, the nature of the conditions that a VC requires to be met (known as conditions precedent) mean that they require a gap between ‘exchange’ and ‘completion’.  In these circumstances, the VC will not be bound to invest until such conditions precedent have been satisfied.

Common examples of conditions precedent an investor might require include:

  • The company obtaining some form of consent, approval or licence if this is relevant to your business – this could be regulatory approval from a body such as the FCA, or approval from BEIS in connection with the National Security and Investment Act 2021.
  • That the company obtains a certain level of additional investment from other investors in addition to the investment received from them. This could be other venture capital funds or from private angel investors.

However, the conditions precedent could include anything which the investor has identified as critical to the business and your growth plans, whether that is one of the general examples listed above, or another requirement more specific to the circumstances of your business.

Any conditions precedent should be clearly set out in the term sheet, so it is important that you take advice at this stage to determine whether or not they are reasonable in scope (please see our article on terms sheets here for more details).

The VC will typically also give itself the flexibility to waive any condition precedent, meaning that they could decide to proceed to completion notwithstanding that one of the conditions has not been met.

Tranched Payments

A VC might seek to spread its investment in a company over a series of tranches. Investors adopt this approach as a way of reducing the risk they are exposed to by only releasing a portion of the total investment at a time. This has traditionally been a common approach in the life sciences sector, but we are seeing it now become more widespread.

Each tranche is typically contingent on certain agreed milestones being met. Usually, these milestones relate to a profitability or turnover metric being achieved, or different stages in the development of a product. Alongside these milestones, you would also typically expect to see some more generic conditions for the benefit of the VC – these can include:

  • No material adverse change occurring to the company
  • There being no breach of the investment documents by the company or the founder
  • The founder still being employed by the company.

Once the agreed criteria have been met, the next tranche of funds can be drawn down, and the corresponding shares issued to the investor(s).

While this is an effective way for the VC to manage and limit its risk exposure, it obviously provides much more uncertainty for your business. If for any reason you do not achieve the agreed targets or conditions for the next stage of investment, this could result in funds previously budgeted for being delayed or cancelled altogether. For this reason, to the extent possible you should try and avoid tranched payments. This may not be an option though; in which case it is important to seek specialist legal advice to make sure that the milestones are as clearly defined as possible.

Post Completion Obligations

Once the investment has completed, you will probably be relieved to be able to get back running and growing your business. However, the investment agreement is likely to include a number of obligations which you must comply with in the period of weeks and months immediately following completion, so it is important that you are alive to these.

This might include some key objectives, such as:

  • recruiting key employees
  • establishing a share option scheme
  • putting in place certain insurance policies
  • rectifying any problem or risk areas identified in the VC’s due diligence process (please refer to our article on due diligence here for a guide on what to expect from that process).

The VC Series – Next Article

The next article in the VC Series will focus on warranties and will provide an overview on the types of warranties you might expect to have to give, their purpose and the extent of the company’s and a founder’s liability under them.

You can find details of all the different articles in the VC Series here.

If there is anything that we have not covered which you would find useful, then please let us know.

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