Whether you need to overcome financial obstacles, create expansion opportunities, or want added expertise, the right investor(s) can fulfill your needs. However, you need an agreement in place to outline your goals and, in return, the compensation investors can expect. Learn how to write an investor agreement and help secure the funds you need to move forward confidently, then speak with a legal professional to execute the contract accordingly.
Investor agreement: What it is and why you need one
Investment agreements are legal contracts between an investor and a company. The investor supplies funds with the intent of receiving a return. In turn, the company protects the individual's financial investment in the business. The Securities Act of 1933 governs investment contracts.
According to the U.S. Securities and Exchange Commission (SEC), an investment contract is only valid if it meets the following criteria laid out by the Howey test:
- It is an investment of money.
- There is an expectation of profits.
- The acquisition is in a common venture.
- Any profit comes from the efforts of others.
A well-executed agreement can help secure the investor's interests and safeguard your company. According to Global Negotiator, "the purpose is twofold": It will ensure you meet your financial undertakings while protecting investor funds without jeopardizing your enterprise. The SEC provides a sample investment agreement, giving you an idea of what it looks like.
[Read more: Business Investors: A Guide to Knowing When and How to Find One]
How to negotiate terms with investors
Negotiating agreement terms with your investors takes a little effort and a lot of foresight. You'll need a deep understanding of your company's needs, the dynamics of the market, and how you want to work together with the investor moving forward. Start by getting an accurate valuation of your company.
"A well-supported valuation gives you the leverage to discuss equity stakes and investment terms with confidence," wrote Visible VC. "This knowledge prevents undervaluation and helps you articulate your business's potential effectively, ensuring that investment terms are fair and reflective of your startup's true value."
As with any business negotiation, take the time to also research market benchmarks. Learn what other companies have received from investors, or consider speaking to multiple investment parties to try to get leverage for better terms. Keep in mind that negotiations are also about building relationships: As much as you want to come to the table prepared, you also want to make sure you don't alienate someone with whom you could be partnering for many years.
A well-executed agreement can help secure the investor's interests and safeguard your company.
Types of investors
An investor can be a person or a business entity. For example, a family member could contribute some of their savings to your company in exchange for shares, or a corporation could invest funds in a joint venture where the corporation itself is the investor.
Five common investor types include:
- Personal investors, like friends and family.
- Peer-to-peer lenders, such as group lending or crowdsourcing.
- Banks, which act as a source of capital for established companies.
- Angel investors, who invest in startups or new entrepreneurs.
- Venture capitalists, including well-off investors and investment banks.
Enterprises typically use investor funds to launch a new business, scale operations, upgrade equipment, or hire new staff. However, each circumstance varies, so UpCounsel suggests seeking legal guidance before contacting investors.
Investor agreement formats
Although the basic information required in investment agreements is the same, the structure differs according to the type of investment. Your financial and legal advisers can help you select the correct format.
The Finity Law Firm lists the most common types of investor agreements as follows:
- Stock purchase agreement.
- Stock option contract.
- Restricted stock agreement.
- Royalty, commission, or percent of revenue.
- Convertible debt agreement.
- Deferred compensation.
[Read more: 3 Investors Demystify Why Some Startups Win Funding Windfalls]
What to include in an investor agreement
A well-executed agreement should include the basics, such as names and addresses, the amount and purpose of the investment, and each party's signatures. In addition, when drafting an investor agreement, the Kumar Law Firm said to be concise and not leave room for ambiguity.
"The terms of the investment should be clearly laid out in the agreement," the firm advised.
Although each investment agreement differs, most should include the following:
- Fundamental terms: Describe the amount and transfer date of the investment and note the tender, such as cash, certified check, or tangible assets. Also, record the allotments of funding, a timeline of when the contract commences and expires, and if the investor gets voting rights.
- Terms of the return on investment (ROI): Determine if and when the investor will receive an ROI. Stipulate what kind of ROI, namely a lump sum payment with the return on their investment, an agreed-upon interest rate paid annually, or a figure based on the project's profitability.
- Other details: Include any restrictions regarding the investor's rights, a strategy for solving disputes, and the consequences for violating the contract. Additionally, the Kumar Law Firm recommended addressing what happens to the funds if the company is dissolved or files for bankruptcy.
How to manage investor relations after agreement signing
Once your contract is squared away, it's time to shift into investor relationship management. Your investors will want regular updates on your progress toward the goals they've agreed to fund. Investor relations can quickly become a core business activity depending on how much you raise, how many investors you recruit, and any compliance regulations that may apply.
It's likely that as you write your agreement, your financial investors will ask for regular financial reports quarterly or annually. Make sure you fulfill those obligations at a minimum. Certain investors, such as angel investors, may also want to take a more active role in mentoring you and your leadership team.
Ultimately, the best approach is to focus on building relationships with your investors and keeping them in the loop as much as possible.
"How investors perceive you as a business manager is as important as any financial metric," wrote Fora Financial. "Actively building relationships helps you control that perception."
This article was originally written by Jessica Elliott.
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