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Should I ask potential investors to sign an NDA before pitching my idea?

A startup, like any new business, is inherently risky, and you’ll want the venture to be as financially and legally secure as possible. But more than that, it’s kind of your baby. It’s something that you have created, and obviously you don’t want someone taking that away from you.

 

So it seems to make sense to want to make every potential investor you show your work to sign a non-disclosure agreement (NDA). It’s meant to keep an investor from having the ability to pass off your hard work to someone else and cut your competitive advantage.


 

It is very likely however, that a potential investor will refuse to sign an NDA before you’ve even gotten halfway through sliding it across the desk towards them. In some circles, it’s actually considered a faux pas.

 

It’s usually not worth it at this point in the relationship

A non-disclosure agreement is meant to keep the potential investor from spreading the confidential information (here, your idea) they have received from you. It  is essentially a promise to keep a secret, and if the investor doesn’t keep it, you have an enforceable legal action available to you. The reality is however, that it is only effective if you can afford to go to court to enforce it.

 

Consider the following points:

  • Though an NDA is meant to build trust on the side of the startup, the vibe an investor will get is, “If you do X, I can sue you.” That sort of attitude will not get you any traction in the tight-knit world of investors.

  • You may not have a lot of cash to successfully pursue a claim based on your NDA—after all, you’re a startup that’s strapped for cash. Isn’t that why you’re looking for investors in the first place? And what other investor wants their money spent on this litigation? Having outstanding litigation may just deter other investors from investing in your company.

  • The life cycle of a startup is potentially like a shooting star, burning bright and ending quickly, so time is of the essence. The courts are notoriously slow—you can’t wait to enforce it anyway.

Instead, strike a balance

You don’t want to come on too strong on the first date, so don’t bring an NDA to your first meeting with a potential investor. That’s a bit too much commitment, and you might not have anticipated all the things that go with it.

 

So here’s a suggestion: strike a balance by changing the way you pitch your idea to investors. If you aren’t comfortable with what you’re sharing, perhaps you’re oversharing. It would be a good idea to consult an intellectual property or patent lawyer to see if you’re at risk of overexposure.

 

A good first pitch is one that gives the investor just a taste. Hook them in with the big idea in all its novelty, and support it with an outline of your business plan, what specific market need it addresses, and an assurance that with how you’re approaching the idea, it would be hard for anyone else to duplicate. Don’t rely upon the technical details of how the idea works, focus on what it does and can do. Save the rest for when that investor is seriously interested— and bring your NDA to that meeting.

 

To see a standard non-disclosure agreement and other documents you may want when securing an investment, visit our Small Business Law Library!

This blog was co-authored by Alina Butt.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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What legal documents are required to connect an inventor with an investor?

Startups depend upon funding, so preparing the right documents can help you obtain the funding you need.

Due Diligence

No matter what stage or type of funding is at hand, the biggest thing that all investors will be concerned with is the quality of the investment. This means assessing any and all risks, whether they are legal, financial, or market-based. A company can make this process smoother by preparing, collecting and organizing the appropriate information. To attract an investor,the company should also properly prepare a few key documents that can assure the investor that the investment is a sound one, and that the company is well-run.

Minute Books

The Minute Book is the official record of the company’s activities. It should include all directors’ and shareholders’ resolutions, corporate bylaws, articles of incorporation and any amendments to the articles, corporate registers including a register of directors and shareholders, share register, subscription agreements, the form of share certificates, the shareholders’ agreement (if there is one) and copies of all major contracts. Investors will want to inspect the Minute Book to ensure that all corporate actions have been properly authorized. It is important to keep the Minute Book up to date and organized.

Term Sheet

A startup should provide a term sheet, otherwise known as a letter of intent. This is a non-binding document meant to lay out the big-picture terms and conditions of the potential investment. This means outlining the structure of the investment, including a timeline for funding as well as the transfer of shares and equity (or other securities) to the investor. Specifications about board structure and responsibilities of the investor can also be included, as well as any substantial points to be included in a future shareholders’ agreement.

Share Subscription Agreement  

If the deal has progressed and the investor is ready to invest in the company, a share subscription agreement will be required. This is the agreement that contains the terms of the deal between the company and the investor—how many shares, at what price, at what time, for what form of payment. Depending on the investor, the company may be required to provide representations and warranties that the startup has no existing undisclosed loans, liabilities, material agreements, or ongoing litigation, and that the agreement will not cause the company to breach any of its other agreements. The subscription agreement also typically contains a statement of the type of exemption being relied upon to exempt the transaction from prospectus requirements under the applicable securities laws.

Shareholders’ Agreement

Now that the investor is a shareholder and interested in how the company is being managed, they may wish to have a shareholders’ agreement in place. The shareholders’ agreement is a flexible instrument that can (among other things) protect the shareholder’s representation on the board, limit the board’s ability to make certain decisions without shareholder approval, or protect the shareholders by giving them preemptive rights when more shares are issued in the future. Many minority investors will want to ensure that the shareholders’ agreement protects their rights and investment.

To see standard versions of the various documents and agreements discussed in this article, visit our Small Business Law Library!

This blog was co-written by Alina Butt.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Role of the Board of Directors: To Protect the Investors

Many early stage companies are directed by a unanimous shareholder agreement, under which the shareholders take control away from the board and make all decisions by requiring a unanimous vote of the shareholders.  This is sensible when there are a small number of shareholders who have self-financed a business.

Reasonably, as a company starts to grow and take on silent or passive investors who are far removed from the business, decision making will start to occur not by shareholder decision but instead, more formally, at a meeting of the board of directors.

The value of a board is its review of company performance against business plan, standards of governance, and forum for debate.   The board is elected by the shareholders at the annual meeting, or at other times when vacancies occur.  Often a shareholders’ agreement will set rules as to which of the shareholders or groups of shareholders have the right to nominate board members.  For example, a company’s founders may require that one or more board seats are filled by company founders or their nominees (by reserving the right to nominate a replacement director should there ever be a vacancy in those seats).  Major investors will often reserve one or more seats, and “minority” investors may also require a seat.

A company will sometimes also leave room for “independent directors” who are not shareholders or stakeholders.  Recently and famously, eBay has appointed an independent director to its board in response to a claim from investors that the company is poorly governed.  Claims from eBay’s billionaire and activist investor Carl Icahn were leading to a potential proxy battle to spin PayPal out of eBay, for reasons of lack of confidence in the governance of eBay.

 This matter was resolved last week when eBay announced the appointment of David Dorman, formerly of (among other appointments) Motorola Solutions, an “independent member” of the board, with the anticipation that shareholder concerns will be brought forward by such independent member of the board.  As business decisions can be complicated and multi-faceted, debate and discussion is a cornerstone feature of a board of directors, along with diversity of experience and context, amongst the members of a board.

It is clear that, whether a company is growing with a handful of investors, or a public company with thousands of investors, once a company’s investors increase in numbers and are far-removed from the day-to-day operations of the business, they will rely on the voice of the board at regularly scheduled meetings to protect their investment.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Entering Into a Term Sheet is Hard Enough, Getting Out of One Can be Even Harder

As a company entering into a possible investment, when accepting an investor term sheet, consider the provisions relating to termination of that term sheet.  There’s nothing worse than being stuck in an unlimited holding pattern while trying to raise funds.

Here are some tips to make sure that your interests are protected.

  1. Set an automatic termination date (30 days, 60 days) that will provide sufficient time for due diligence and receiving and reviewing legal documentation.

     (The termination date can be extended after that day by written approval).

  2. Make sure that the termination provision is in writing (can be in a non-binding term sheet with certain binding provisions, including the termination mechanism).
  3. Avoid a term that requires the company to pay legal fees, unless the deal successfully closes.
  4. Honour the “no-shop/break fees” clause (if any) i.e. do not start shopping the deal around, or you may be on the hook for paying the agreed-upon break fees.
  5. Don’t start performing as if the deal has closed until it actually closes i.e. until funds are transferred, documents are signed, and so on.  The court has looked at “non-binding” deals in which the parties starting to work together, co-market and so on, and in some cases has considered that the deal had actually closed based on such (and other) performance by both parties.

     In doing so, the court has found that a “non-binding” term sheet is therefore binding.

Reviewing multiple term sheets can be tricky.  In some cases the investors will welcome co-investors, and will agree that a lead investor can protect their interest, can be responsible for management decisions, and so on.  In other cases, the investors will consider themselves competing.  When faced with multiple term sheets you as a company should consider the long term strategic relationship that you are looking to develop, trust your instincts, and make sure that you consult with your trusted advisors and legal counsel before selecting your investor.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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When Fundraising, “Know” Your “Accredited Investor”

Links from this article:
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When raising money in Ontario or Canada for your startup company, you fall under the scrutiny of the rules of the Securities Act and related National Instruments that set the rules on the nature and type of disclosure that you need to provide to your potential investors.  In all cases you are required to provide a prospectus (which is a detailed document outlining the risks and details of the business to invest in), unless your fall under a prospectus exemption.  I’ve written about prospectus exemptions in the past (see here).  My past article describes the Accredited Investor Exemption which is often used when raising money from “arm’s length parties”, and that is the topic of this blog post.

Determining if your investor is “accredited”

I’m often asked what steps should be taken to confirm that investors are accredited.   When raising money from accredited investors, it is the responsibility of the company raising money to determine whether the accredited investor test is met.  Other than relying on a statement by the investor as to their net worth or earnings, how can a company confirm that they truly are a member of that category?

Best practices for confirming/recording the status of potential investors include:

  • Reasonable efforts to ensure that the purchaser understands the meaning of the definition of “accredited investor” through discussion and written explanation;
  • A certificate of independent legal advice from the investor that the investor documents were reviewed by their own counsel who provided advice on same;
  • Receipt of a signed document by the investor indicating which exemption is relied upon, and better still, specifics on their “fit” in the category;
  • Signed letter from the fundraising board director/executive indicating which exemption is relied upon (in the future if the fundraising party has moved on to another company, having this documentation on file will potentially be useful).

It is useful and prudent to review supporting information wherever possible:

  • with respect to purchasers who are accredited investors based on income, a review of tax returns for the past two years and obtaining a written representation from such person that he or she has a reasonable expectation of reaching the income level in the current year;
  • with respect to purchasers who are accredited investors based on net worth, the issuer reviews bank statements, brokerage statements, other statements of securities holdings, in order to verify assets, a consumer report from at least one of the nationwide consumer reporting agencies to verify liabilities and obtains a written representation that all liabilities necessary to make a net worth determination have been disclosed (all information reviewed may not be more than 3 months old); and/or
  • confirmation from the accountant, broker or lawyer of the accredited investor in writing that they have confirmed that such purchaser is an accredited investor.

After funds are raised using this exemption, disclosure of this financing should be filed with the securities regulator in your jurisdiction.  It is important for companies raising money to conduct this process carefully with a view to investor protection.   Always consult with legal counsel to ensure that you’re properly navigating the fundraising process.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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