Catriona Brown continues her series of posts digging into the Heads of Terms that usually end up in your Inbox before anyone will invest in your business. Today, she points out what you need to know about conditions precedent.
My last post in the series of plain English explanations of standard heads of terms started gently by looking at how you define what your business does, whilst running you through some of the maths that lie behind the pre- and post-money valuation attributed to your company by investors.
The investors’ clock is ticking…
Next up, let's look at Conditions Precedent. A fancy name but with an obvious purpose, these are the conditions that the company must fulfil before the investors will release their cash. Realistically, it’s unlikely that any investment documents will be signed before these are met or (occasionally) waived by the investors. So, it’s worth taking a look at what investors expect and make sure you are confident you can satisfy all conditions precedent in the timescale between receiving the heads of terms and when you hope to complete the investment.
Examples of standard Conditions Precedent
- Investors being satisfied with the due diligence carried out and the content of any due diligence report
As you may have read about previously on this blog, due diligence is the investors' way of finding out whether there are any serious issues affecting the company. As a condition, the final assessment of whether this condition has been met is in the hands of the investors. It is, however, a clear requirement.
Due diligence usually covers a raft of information, including the existing share structure and incorporation of the company, who the directors are, details of any intellectual property rights which the company has (or believes it has), whether there are any material contracts to which the company is a party and whether there are any disputes ongoing which could affect the company.
Information provided at the due diligence stage sometimes informs whether further conditions (precedent) should be attached to the investment, or, in extreme cases, whether the investors will walk away from the deal.
- Investors being satisfied with the content of the Business Plan
The business plan, in addition to the presentations you’ve given to investors, along with (obviously) knowing a good thing when they see it, is used by investors in making the decision about whether or not to invest.
The business plan will form the basis of warranties (which I’ll cover in a later blog) which you are expected to give and provide the framework within which the investment funds can be spent. It is also worth noting, however, that it is subject to the same subjective assessment as the due diligence.
- Giving “standard” or “customary” warranties for a transaction of “this” nature by the company and management
The warranties which you are expected to give serve two principle purposes. Firstly, to flush out further information which could reveal problems with the company. The second purpose of the warranties is that they form the basis upon which the investors could sue the company and/or the managers in the event that any of the statements comprising the warranties (which are “warranted” as true) turned out not to be.
- To the extent it is not already owned by the company, the Business being transferred / licensed to the company including intellectual property rights used or developed for use in the Business
“Business” in this context, will mean business of the company as defined in the heads of terms (read Part 1 of the series for a brief elaboration of this).
Owning the intellectual property, which includes anything from website content, domain names, and patents to “know how” (the stuff in your head that gives the company its edge) is key to investment. The intellectual property used in running the business is what helps make your startup unique. The company should own (or have legal rights to use) everything it needs to carry on the business.
The Heads may ask about intellectual property rights that have been licensed to the company. This is usually investigating situations where technology might have been ‘spun out’ into a separate company to develop. It usually relates to spin-outs from universities or other (bigger) companies. In these cases, the original entity will often look to retain ownership of any intellectual property until the startup is at a certain stage of its development so a licence of the IP in this case is more appropriate. This general condition can lead to more specific conditions, including IP transfers from individuals, or licences of software/technology.
The number of conditions depend on the deal itself
That’s a quick and by no means exhaustive run through of conditions precedent in the Heads of Terms. Hopefully, the hurdles are not too high in most cases and, with a certain amount of careful planning, both upon receiving the Heads of Terms and in the months before the investment when originally structuring the company, they can often be as useful to the business that is trying to keep its house in order as to any investors.
As with all posts in this series, I’d love to hear whether there are any particular areas in heads of terms that you’ve read about which appear to be a bit of a riddle.