“You Can’t Fight for Your Rights If You Don’t Know What They Are”
Investment in a startup is an opportunity to enter a new industry, a new market and develop a long partnership with your investees. Though, sometimes it can be a little scary to fully comprehend the terms and conditions entailed in the deal documents. A typical deal agreement covers five key areas – deal economics, investor rights, governance, management and control, and exit. We have worked closely with thousands of businesses, business buyers and investors over the last 5 years, and in this article, we will share with you the key rights that are available to an investor in a startup.
Rights Against a Down-round: This right is called Anti-Dilution Right, and it protects the investor from devaluation of his stocks against any future investment into the startup at a lower price or valuation. If there is a down-round, i.e., the business raises the next investment at a lower valuation, then the prices of shares of the earlier investors are also reduced to the current price with retrospective effect. The adjustment is reflected by a proportionate increase in their shareholding percentage. Need a refresher on business valuation? The following article tells you in a nutshell everything you need to know about business valuation.
Rights Against Investor Overriding: This provision is collectively referred to as ‘Control Rights,’ and it makes the business owner liable to communicate and take approval of the investors for any material changes in ownership, business model, strategy, any material transaction, contracts, and so on. Control Rights are usually negotiated between the investor and the business before finalizing the agreement, however, at the end of the day, the stronger your partnership with the investee, the more you can stay involved in the startup. Here are some additional tips you should remember when investing in a small business.
The right of First Refusal (ROFR): What if a business owner or promoter decides to sell a part or all of his shareholding? ROFR gives the investors precedence over any third party when it comes to purchasing the owner’s / promoter’s shareholding. It is only when there is a written refusal from investors to buy the promoter’s stocks that a third-party sale can be initiated. How does this protect the investor? Note that as an investor you not only bet your money on the startup but also on the people running it – i.e., the owners or the promoters. You can avoid onboarding an unknown third-party by exercising ROFR.
While we have tried to explore the key investor rights briefly in this article, a professional deal consultant can help you understand the full plethora of rights available to an investor, and help you negotiate the same. Indiabizforsale.com is India’s most preferred business opportunity platform that is trusted by over 25,000 business owners, investors, buyers, consultants and investment bankers. To know more about what we do and how we can help you, explore us.