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‘The VC Series’ is a series of articles aimed at founders who are thinking of raising funds from venture capital investors. Further information about The VC Series can be found here.
When making an investment, a VC will expect the company and, often, the founder to give them warranties.
This article gives an explanation as to what warranties are, who gives them, and how founders and the company can mitigate their risk.
What are Warranties?
A warranty is a contractual statement of fact as to the condition of the investee company.
The warranties will normally be included as a schedule to the Investment Agreement or Subscription Agreement and for an example of the sorts of warranties that a VC might expect, go to Schedule 5 of the BVCA’s ‘Model Shareholders’ and Subscription Agreement’ here.
For a VC (and other investors), the warranties serve two main purposes:
- As a means to flush out information that has not already been disclosed to the VC (see the section on Disclosure below).
- To allocate risk and to provide the VC with the right to bring a claim for financial compensation against the party/ies giving the warranties if the state of the Company is not as it seems.
Of the above, the first point is typically the most important to VCs on the basis that they will be very reluctant to bring a claim against a company in which it is invested, or against founders who they are working alongside. It is therefore important to the VCs that they are aware of any issues in advance so that they are making the investment with their eyes wide open.
Who gives the Warranties?
As it is the company in which the VC will be making its investment, the VC will typically expect the company to be giving the warranties.
In addition to this, it is often expected that the founder(s) will stand behind the warranties given that they are the ones who are responsible for running the company day-to-day. This is also seen as important to the VCs as it will encourage the founder(s) to give proper attention to the disclosure exercise (see below). This can though be a point for negotiation.
When are the Warranties given?
Assuming that there is a simultaneous exchange and completion, then the warranties will be given on the date of the agreement (i.e., the date on which the VC makes its investment).
Warranties are only true at the moment they are given, so where an investment is tranched over two or more completions, the VC might expect the warranties to be repeated on such dates.
See our article on ‘Completion’ for more detail as to simultaneous exchange and completion and the tranching of investments.
Mitigating Risk – Disclosure
The starting point is that, if a warranty proves incorrect, then the VC will be entitled to bring a breach of contract claim against the party/ies giving the warranties.
However, crucially, the VC will not have any right to bring a claim to the extent that the matters relating to the breach had been disclosed to them at the time of the investment.
By way of example, a typical warranty is that the company is not involved in any disputes. If this is not true, then the party/ies giving the warranties will need to disclose details of the relevant dispute(s), either in a standalone ‘Disclosure Letter’, or in a ‘Disclosure Schedule’ attached to the Investment Agreement. The VC will then have no right to bring a claim for breach of warranty in relation to that dispute.
Mitigating Risk – Limitations
In addition to disclosure, the party/ies giving the warranties will also typically be able to limit their liability for claims in a number of other ways – common ways of achieving this are:
- Agreeing a maximum amount that can be claimed by the VC under the warranties – in so far as the company is concerned, this would typically be limited to the aggregate amount of the investment, or a percentage of it, whereas for the founders it would often be by reference to a multiple of salary.
- Limiting the period of time in which a claim can be brought
- Setting a minimum claim value, below which the VC will not be entitled to bring a claim.
How can we help?
Negotiating the scope of the warranties and limitations and conducting a thorough disclosure process are key parts of any VC investment and offer a vital opportunity for the company and founder(s) to mitigate their risk.
Specialist legal advice should be sought as early as possible, and we would be delighted to support you through the process to help ensure you do not unnecessarily expose you or the company to risk.
The VC Series – Next Article
The next article in The VC Series will deal with some of the investor rights that VCs will typically expect to receive in consideration for its investment.
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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