Venture capital is a form of financing that is typically provided by venture capital firms or funds to companies that are in a growth stage in exchange for equity securities of such companies. In recent years it has become standard in the venture capital industry to use a number of different documents in such financings. The following is a list of some of the main documents that are customarily used as well as a brief summary of the various contents of the respective documents.
- Certificate of Incorporation: According to Delaware General Corporation Law (the DGCL), the Certificate of Incorporation is a document that must be adopted and filed for a Company to be considered duly incorporated. In other jurisdictions it may be titled differently (e.g., in California it is titled Articles of Incorporation). While the Certificate of Incorporation must include certain basic information such as the name of the company and the classes or series of stock the company is authorized to issue, it also typically includes a description of the company’s stock. This description often addresses the rights, preferences, privileges, and restrictions of each class and series of the company’s stock. Specifically, a large part of the Certificate of Incorporation often focuses on the rights of the preferred stock, including the right to receive dividends, liquidation preferences (i.e., the right to receive the proceeds of any liquidation, including any proceeds paid in the context of any exit, before any proceeds are distributed to the holders of any junior securities), rights to convert the preferred stock into common stock, and events that trigger mandatory conversion (customarily, IPOs meeting certain threshold of valuation and proceeds to the company), redemption rights, anti-dilution rights, and certain preferred veto rights.
- Stock Purchase Agreement: The Stock Purchase Agreement contains the terms of the purchase and sale of the stock to the investors. Similar to a Stock Purchase Agreement in an M&A context, it typically contains the purchase price, representations and warranties from both the company and the investors, and conditions to closing.
- Voting Agreement: The Voting Agreement is an agreement among the shareholders of a company. It often contains provisions relating to the control and management of the company by regulating the size of the board and the manner in which the board is selected. In addition, the Voting Agreement may outline drag-along rights, which force minority shareholders to vote in favor of and join a sale in which the majority shareholders have sold their stake (hence the minority shareholders are “dragged-along” for the sale by the majority shareholders).
- Right of First Refusal and Co-Sale Agreement: The Right of First Refusal and Co-Sale Agreement is an agreement by which the founders, and in some cases some or all of the existing shareholders (the Key Holders), may not sell their shares of the Company without first providing the investors, and in some cases the company, with the right to purchase the shares. If the company or the investors decline to purchase the shares, the agreement grants the investors with the right to participate in the sale pro-rata based on the number of shares held by the Key Holders and the investors.
- Investors’ Rights Agreement: The Investors’ Rights Agreement may often contain a wide-range of provisions. Among them, it may contain information rights that outline how information regarding the company (i.e., certain financial information) will be shared with the shareholders who hold a certain threshold of shares (e.g., holders of 5 percent of the shares). The agreement often contains demand registration rights, which allow shareholders who hold a certain amount of shares (e.g., holders of 40 percent of the shares) to force the company to register the shares of common stock for trade in a stock exchange, thereby allowing the shareholders to sell their shares to the public. The agreement may also contain a provision granting the investors preemptive rights in the event of a future stock issuance by the company, subject to certain customary exclusions.
As noted, venture capital investments often use these documents, among others, although they may vary (sometimes all the provisions of an Investors’ Rights Agreement, Right of First Refusal and Co-Sale Agreement, and Voting Agreement, will all be combined into a single Stockholders Agreement). Variations also appear with respect to the contents of specific provisions (e.g., the scope of the liquidation preferences, the events triggering conversion, the scope of the rights first refusal). As discussed in this summary, it is important to understand the differences of the various documents that are commonly drafted in a venture capital financing.