An investor agreement is a legal contract between a company and an investor. It’s an important business document that sets out the key terms of the investment.
In this guide, we’ll explore what an investor agreement is, its types, how it differs from a shareholders’ agreement, and what to include in it. At the end of the article, we’ll also explain why writing your company’s investment agreement without professional guidance is a bad idea and how a team of experienced lawyers could help you draft one for you.
What Is an Investment Agreement?
An investment agreement—also called an investor agreement, an investment contract, and an investor contract—is a legal contract between a business and an investor. It’s a formal agreement that sets the conditions, terms, and mutual commitments between parties.
An investor agreement is drafted and signed by a representative of your business and an investor who proposes to inject capital into the company. It covers any such transactions that provide individuals or organizations ownership interest in your enterprise.
Governed by the Securities Act of 1933, investment contracts are critical documents for your organization, as they help your enterprise and its investors identify and manage the risks that arise when you raise new funding. As legally binding agreements, they allocate risks, as well as define each party’s rights and duties. Investment contracts also include provisions to distribute tranches of funding, resolve disputes, manage exits, and deal with other important matters.
The goal of investment agreements is to lay down the key terms of this investment, which could vary by the type of funding the investor offers your business.
What Are the Different Types of Investor Contracts?
The type of funding investors offer your company determines the form of the investor contract. Regardless of the structure, each agreement should cover the transaction that grants an individual or organization an ownership stake in the business.
1. Term Sheet
A term sheet is a non-binding agreement that outlines the basic terms and conditions under which an investor will inject capital into your business. Mostly used for startups, it serves as a template and basis to draft more comprehensive, legally binding documents between investors and your company.
Even though its terms can’t be enforced in court, the term sheet is still among the most important small business investor contracts. By covering the most substantial aspects of the deal, it ensures that your company and its future investors are on the same page. This helps avoid misunderstandings and attract new capital to your organization.
The term sheet includes important information about the investment, such as the initial purchase price, assets, valuations, investors’ commitments, voting rights, and major contingencies that may impact the cost.
2. Share Purchase Agreement
A share purchase agreement (SPA)—also known as a stock purchase agreement—is a formal contract that sets out the terms and conditions for the sale and purchase of your business’s stocks. It should clearly define the following:
- Who’s buying the asset,
- Which asset is being sold,
- How much the buyer is paying for the asset, and
- Other relevant liabilities and obligations.
Unlike term sheets, a share purchase agreement is a comprehensive binding document that’s normally prepared by your company’s lawyer. You may need financial reports from your accountant or due diligence exchanged between each party’s attorneys before drafting the contract.
3. Simple Agreement for Future Equity (SAFE)
A simple agreement for future equity (SAFE) is a flexible agreement between your business and an investor, which provides the investor with future equity rights without immediate valuation. Commonly used for early-stage startup funding, SAFEs were introduced in 2013 by the tech firm Y Combinator to offer startups a faster and more straightforward fundraising alternative to convertible notes and equity financing.
In a SAFE transaction, an investor invests in your organization without determining its valuation or receiving shares right away. Instead, their investment converts into stocks after an acquisition, an equity funding round, an initial public offering (IPO), or another predefined triggering event takes place. This conversion is normally offered at a discount or a valuation cap to incentivize early investments.
To ensure their flexibility, SAFEs don’t accrue interest or have a maturity date, which could make them more attractive to startups. On the other hand, investors will gain voting rights and ownership in your business only after the conversion occurs following a triggering event.
4. Stock Option Agreement
Stock options provide an investor, employee, contractor, consultant, or another entity the right to purchase your business’s shares at a predetermined price at the date of expiry. A stock option agreement—sometimes also referred to as a share option agreement—is a formal contract that defines the terms and conditions related to this transaction.
As its name suggests, a stock option grants the buyer the right, not the obligation, to purchase your company’s shares at the expiration date. The most beneficial scenario for the buyer is when the value of your business’s stocks increases until expiry. This allows him to exercise his right and acquire the shares at a discount.
A stock option agreement can be statutory or non-statutory. Statutory options are governed by the Internal Revenue Code, taxed more favorably, and subject to strict rules and regulations. On the other hand, non-statutory options represent unrestricted stock options that can be produced relatively quickly and without the rigorous compliance requirements of their statutory counterparts. That said, non-statutory options must still follow the US Securities and Exchange Commission’s (SEC) rules.
5. Convertible Loan Agreement
A convertible loan agreement or a convertible debt agreement is a contract in which your company agrees to provide a convertible loan note to an investor in exchange for lending money to your business.
A convertible loan note is a debt instrument representing a loan made to your enterprise. What differentiates convertible loan notes from ordinary debts is that investors (noteholders) have the option to convert them into your business’s shares at a future date. In the case of startups, this trigger event is usually a predefined milestone or the next equity financing round.
Normally, convertible loan notes are issued by early-stage startups that seek rapid access to capital but pose high risks to investors. As an alternative to equity financing, convertible loan notes mitigate these risks and enable startups to acquire the necessary funding in their early stages.
6. Restricted Stock Agreement
A restricted stock agreement—also known as a restricted stock purchase agreement—is a stock agreement that restricts the sale or the transfer of an investor’s purchased shares in your business until certain predefined conditions are met. In addition to these shareholder limitations, the contract may provide your company with specific rights. Examples of such may include the right of first refusal and share buybacks.
Generally, restricted stocks are issued to your business’s executives, directors, managers, and other employees as compensation. Common terms defined by restricted stock agreements include vesting schedules, repurchase rights, as well as single or double trigger acceleration.
Restricted stocks have two primary variations:
- Restricted stock units: A restricted stock unit represents your business’s promise to provide a specific number of company stock shares at a predetermined time. As restricted stock units only grant a right to the promised stocks, they offer their owners no voting rights until their conversion.
- Restricted stock awards: Similarly to a restricted stock unit, a restricted stock award also represents a right to your business’s shares. The main difference between the two is that restricted stock awards provide their holders with immediate ownership over the stock, which also grants them voting rights.
Is an Investment Agreement the Same as a Shareholders’ Agreement?
Investment agreements and shareholders’ agreements are often used interchangeably, yet the two contracts serve different purposes.
Investment Agreement
An investment agreement is a formal contract between your business and an investor, which sets the conditions under which they invest capital in your company. With the allocation of risks and the definition of parties’ rights and duties, it details the terms and provisions for the investment and the legal protections to safeguard both parties and enforce their rights.
Importantly, investor agreements cover the transactions that give investors ownership interest in your business.
Shareholders’ Agreement
A shareholders’ agreement (or shareholder agreement) represents a contract between your business and its shareholders. Instead of focusing on the terms governing new investments, it’s a more general document detailing the overall relationship among all your company’s shareholders.
Common terms of a shareholder agreement include share transfers, day-to-day operations, future sales, dispute resolution, and voting rights.
Some of the terms of a shareholders’ agreement may overlap with the ones set in an investor agreement. However, while the latter document is transaction-specific, shareholder agreements represent comprehensive guidelines applied to all shareholders to lay the foundation for your business’s investor relations and governance.
What Should an Investor Agreement Include?
Based on the type of funding and the preferences of parties, investor agreements include a set of terms and conditions to manage risks, identify roles, resolve disputes, and protect both your business and its investor.
Investment Terms
Investment terms define the rights, obligations, and expectations of your business and the investor in an investor agreement. Their purpose is to protect the interests of all parties involved, mitigate risks, and clarify financial returns.
Investment terms should specify the investment amount, the valuation of your company at the time of the investment, as well as tranche payments and the milestones you need to achieve to unlock them. They may also define the following:
- Vesting schedules for the shares of founders and other employees
- When dividends will be paid out to investors
- Conversion rights for convertible notes
- Liquidation preferences in the event of your company’s sale or dissolution
- Anti-dilution provisions to protect investors from their investment’s potential loss of value
Legal Protections
An investment contract has legal protections in place to ensure the security of parties against different risks related to the transaction and compliance with laws and regulations.
For instance, investors may request warranties from your company related to its legal standing, financial status and performance, and the accuracy of the information provided to shareholders. This helps them claim damages if they suffer a loss because you made untrue statements about your business.
In exchange for the investment, you may also include restrictive covenants in the contract to prevent, limit, prohibit, or restrict the actions of your company and its employees. For example, you or other founders could agree not to join competitor organizations or launch new projects that could compete with your enterprise.
It’s also a sound strategy to outline confidentiality provisions in the investment agreement to protect parties’ sensitive business data and set up a straightforward process for disclosing information about the deal.
Governance
The investor agreement should also specify investors’ level of oversight, influence, and control over strategic decisions of your business, such as mergers and acquisitions, the appointment of new executives, and additional funding rounds.
In terms of governance, it’s important to define the classes of shares that offer investors the right to vote on corporate policy-making matters. Normally, common stocks grant their holders voting rights. But this may not apply to preferred stocks or other classes of equity in your business.
In addition to voting rights, an investor may also be offered a seat on your company’s board of directors or the right to observe corporate meetings based on their ownership share. You may also grant the board of directors veto rights as part of a set of reserved matters, which could prevent the enactment of a proposal if its members refuse to approve it.
Exit Strategy
Including an exit strategy in the investor agreement helps settle unresolvable disputes, business insolvency, or when a shareholder seeks to withdraw their investment from your company.
To prepare for such cases, the contract should include provisions for the departing party’s shares. For example, it should contain information on whether to offer these stocks to shareholders, your business, or an independent third party, and in what order.
In addition to defining a clear and straightforward process for exits, you should also provide a plan to repay creditors if your business becomes insolvent in the investor agreement.
How to Draft an Investment Agreement?
Raising investment is a significant milestone for your business. As a formal contract, an investor agreement defines this investment’s terms, conditions, and provisions, ensuring that all parties have enforceable rights and responsibilities.
A well-drafted investor contract is critical for your business’s long-term success and growth. That’s why writing one on your own can be risky, and it’s essential to seek professional help instead.
At Gordon Law, our seasoned team of attorneys have over a decade of experience in fast and thorough contract representation and focused industry knowledge in sectors like ecommerce, marketing, esports, crypto, and more. We draft clear, enforceable investor agreements tailored to your specific business needs.
Our contract lawyers work efficiently, with meticulous attention to detail, to safeguard your company’s interests. With a unique blend of tax and business law, we prevent surprise tax bills by ensuring the proper deal structure.
At every stage, our goal is to maximize your company’s profits while providing strong legal protection. If anything comes up during the process, you can reach out to our team with confidence and we’ll provide clear and timely responses to all your questions.
Ready to lay the legal foundation for the long-term success of your business? Schedule a consultation with one of our seasoned contract lawyers to draft a well-structured investment agreement for your company in no time!
Frequently Asked Questions (FAQ)
Is there an investment agreement template or sample I can use to draft a contract for my business?
We strongly advise against using an investment agreement template to write a contract for your business. While samples could help you draft the document in a matter of a few minutes, they fail to account for the unique aspects of your company and investment situation.
Investor agreement templates often oversimplify or omit crucial legal details, such as investor rights, warranties, and compliance with relevant laws and regulations. They also lack the terms, conditions, and provisions that could protect your business from risks, such as unfavorable exit strategies, major disputes between parties, and investor rights hindering the efficiency of your business’s governance.
Instead of using a sample, you should hire professional assistance from a seasoned team of attorneys to draft a well-structured, compliant, clear, and legally binding investment agreement tailored specifically to your business’s needs.
What is an LLC investor agreement?
An LLC investor agreement is an investment contract between a limited liability company (LLC) and an investor. It outlines the terms and conditions for contributing capital to your LLC in exchange for equity or ownership interest.
An LLC investor agreement defines how the investment in your LLC is structured and managed. While they may vary based on the form of funding, common contract terms include the investment amount, the limited liability company’s valuation, tranche payments, investor rights, legal protections, and exit strategies.
What are small business investor contracts?
Small business investor contracts are legal agreements between a small business (SMB) and an investor. These transaction-oriented documents set the terms and conditions under which investors will inject capital into your SMB.
Due to their use cases for startups, term sheets, simple agreements for future equity (SAFEs), and convertible loan agreements are common examples of small business investor contracts.
