Most companies in their startup and early-stage phases raise capital by selling common preferred stock in private placements to friends, family, and angel investors under an exemption allowed by the securities laws. For this type of transaction, the key level elements revolve around the stock purchase agreement. This principal document will range from simple to complex depending on the sophistication of the investor, the maturity of the company, and the complexity of the transaction. It may contain only basic provisions to comply with applicable securities laws’ requirements, or it may also include a variety of sale provisions and extensive representations, warranties, positive covenants and negative covenants by the company issuing the securities and the people associated with the issuer, including the company’s founder and management.
KEY POINT: You and the company’s other owners (if any) will want a simpler document. The investors want a more complex document, with as much protection for them as possible in writing
The detailed characteristics of the security (which, for example, might be a complicated convertible preferred stock) are listed in the body of the stock-purchase contract. Key elements of this contract are representations, covenants, closing conditions, and registration rights.
The beginning of a stock-purchase contract, that include details about patents owned or licensed by the company, major real estate and equipment, and key leases and contracts. In addition, general representations will be made on a variety of subjects, including organization and authority, corporate action, capitalization, governmental approval, absence of litigation, employment of key personnel, compliance with other agreements, ownership of assets, insurance, taxes, environmental protection, and insider transactions.
Covenants are promises made by the company as part of the stock-purchase contract. Common covenants include commitments to maintain life-insurance policies on key executives, to supply regular financial reports and periodic projections to major investors, and to use management’s best efforts to elect persons nominated by the investors to the board.
Closing conditions usually fall into two major categories:
- Conditions on the timing of the payment of funds which specify whether full payment for the securities being purchased is to be made at closing, or whether payment will be staged over an extended period and conditioned on the company’s reaching certain targets.
- Standard closing provisions include an affirmation that the representations made in the purchase contract were true at closing, the receipts of certain certificates from the officers of the company, and an opinion from counsel to the company that the pertinent agreements are valid, binding, and enforceable.
Registration provisions of a stock-purchase agreement establish the circumstances that require the company to register its securities with the Securities and Exchange commission. This is usually as soon as the company is eligible to register because unregistered securities cannot be resold to the public. Clearly, investors prefer securities registered with the SEC because investors then have the option to sell their securities privately or publicly. Because registration broadens the market for the company’s securities, it also increases their value.
WATCH THIS: From the company’s standpoint, granting registration rights can be very expensive in money and time. First, there are filing fees and charges by accountants, lawyers, and printers. Then, filing can divert management’s time and efforts at critical periods. In addition, the sale of the company itself to raise new capital by public sales.
The two forms of registration provisions are demand rights and piggy-back rights. Demand rights require the company to use its best efforts to register securities when and in the amount desired by investors. Piggy-back rights allow investors to require the company to register securities if the company is already registering other securities.