Founder's Guide to Venture Financing

For early-stage technology companies seeking venture financing, navigating the legal and f inancial intricacies of fundraising can feel overwhelming. Among the tools designed to simplify and standardize the process for founders and investors alike are the NVCA Model Documents. These documents, created by the National Venture Capital Association (NVCA), provide a framework for venture capital transactions designed to promote consistency, fairness, and efficiency. In this post, we’ll explain what the NVCA Model Documents are and break down each key document’s role in the venture financing process.

What Are The NVCA Model Documents?

The NVCA Model Documents are a set of standardized legal templates designed to streamline venture capital financings. They are widely accepted in the United States startup and venture capital ecosystem, providing a common starting point and negotiating structure for venture capital transactions. By using these documents, founders and investors can save time and legal expenses while focusing on the deal’s substantive terms.

Key NVCA Model Documents and Their Roles

1. Term Sheet

The NVCA Term Sheet outlines the high-level terms of the investment. While it’s non-binding (except for certain provisions like confidentiality or exclusivity), it sets the stage for the formal agreements that follow. Key terms include the valuation, investment amount, liquidation preferences, and board composition. Founders should pay close attention to these terms as they influence the final agreements. Each deal has its own dynamic between the investor and the Company – in some instances, a more detailed term sheet can be effective in minimizing back and forth between each party’s lawyers. However, some companies or investors prefer to keep term sheets brief and focused on key terms only, with the hope and expectation that both parties will negotiate in good faith and in recognition of market standards.

2. Stock Purchase Agreement (SPA)

The SPA formalizes the purchase of your startup’s shares by your investors. It includes detailed provisions about the purchase price, the closing process, and representations and warranties made by the company and investors. This document ensures clarity and mutual understanding of the investment terms and provides critical representations and warranties by the company designed to protect the investor. A crucial step in any venture capital financing using the NVCA Model Documents is having the founders (and other key executives) meet with corporate counsel to review each representation and warranty in Section 2 of the Stock Purchase Agreement to ensure each statement is accurate and if not, to disclose necessary information on the disclosures schedules that will be appended to the SPA. A thorough approach here provides critical protection to the founders against the risk of a claim being brought by investors in the future claiming breach of a representation or warranty.

3. Investor Rights Agreement (IRA)

The IRA governs the ongoing rights of investors post-investment. It typically includes:

• Information rights: Investors’ access to financial and operational updates.

• Registration rights: Investors’ ability to sell their shares in a public offering.

• Rights of first refusal and co-sale: Protections in the event of future share sales.

• Protective provisions: Safeguards requiring investor approval for certain company actions.

4. Voting Agreement

The Voting Agreement dictates how shareholders vote on key corporate matters. This document often dictates board composition setting the balance (or imbalance) between founder and investor representation. If the company is giving investors a board seat, many funded early stage startups aim for a 2-1-1 board arrangement with two founders, one investor director, and one independent director though many permutations can take place. The Voting Agreement also outlines provisions for drag-along rights, which compel minority shareholders to participate in certain transactions approved by the majority.

5. Amended and Restated Certificate of Incorporation (Charter)

The Charter is the only publicly filed document that formalizes the company’s capital structure and the rights of various classes of stock providing the company with legal authorization to sell its stock. Key provisions include:

• Liquidation preferences: The liquidation preferences sets out the prioritization of payouts in an exit or dissolution event.

• Dividend rights: The Charter details how and when dividends are distributed among shareholders.

• Protective Provisions. The Charter typically contains protective provisions that restrict the Company from taking certain actions without requisite investor approval.

• Anti-dilution protections: These protections safeguard investors in the event of down-round financing.

6. Right of First Refusal and Co-Sale Agreement (ROFR/Co-Sale Agreement)

This document governs how existing shareholders can sell their shares. It gives the company and investors the first right to purchase shares before they are sold to third parties and often includes provisions for investors to participate in sales to maintain their ownership percentage.

Why NVCA Model Documents Matter for Founders

Using NVCA Model Documents helps founders:

• Save Time and Costs: Pre-drafted templates reduce the time and expense of drafting agreements from scratch. Instead, lawyers can take the negotiated term sheet and tailor the NVCA Model Documents accordingly.

• Ensure Fairness: The documents reflect industry-standard terms, balancing the needs of founders and investors. The NVCA has also partnered with companies like Aumni to make more market-level data available on transactions helping to level the playing field for founders.

• Focus on Negotiation: By standardizing the structure, both parties can concentrate on tailoring specific terms to their needs.

Tips for Founders

1. Understand the Key Terms: Familiarize yourself with the essential provisions and their implications for your company’s future.

2. Work with Experienced Counsel: Engage legal advisors as early as possible (even before beginning discussions) who regularly handle venture financings and are familiar with NVCA documents. It is important to have a relationship with a firm and attorney you trust that can allow you to move with appropriate speed once investment discussions commence.

3. Think Long-Term: Amidst the pressure and chaotic pace that financings often involve, be sure to carve out time to consider how the terms will affect your company’s growth, future funding rounds, and exit strategy. Taking this step with due prudence can be the difference in the outcome of your startup venture.

By leveraging the NVCA Model Documents, founders can approach venture financing with greater confidence and clarity. These documents provide a robust foundation for building successful partnerships with investors, allowing you to focus on scaling your business.

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