Stepping into the world of startup funding can be as tricky as it is exciting. To help you navigate it, here we will explain the five key legal terms every founder should know. Whether you're just starting out or gearing up for a big funding round, understanding these terms will help you secure the best deals and protect your startup's future. Let's ensure you're well-prepared for your next investor meeting!

1. Reverse Vesting

Reverse Vesting is a mechanism used to ensure that founders remain committed to their startup over a specified period. Under this arrangement, founders receive their shares upfront but must earn the right to keep them through continued involvement with the company. If a founder leaves before the end of the predetermined period (agreed during the fundraising process), they forfeit a proportionate share back to the company or where pre-agreed, back to the remaining founder(s). This method is often used by investors to mitigate the risk of a founder departing prematurely, which could destabilise the company’s growth and development.

2. Investor Consent Matters

Investor Consent Matters refers to clauses in investment agreements where certain decisions cannot be made without the approval of investors - typically a majority of investors or where there is a major lead investor, that lead investor. These typically include major decisions like selling the company or closing it, creating additional classes of stock, taking on significant or any debt, or changes in the business model. This consent provides investors with the power to prevent founders from making unilateral decisions that could adversely affect the company's value or the investors' interests. It’s a safeguard for investors but can sometimes limit the founders' ability to act swiftly. Therefore, it’s vital to carefully review any agreements upfront.

3. Pre-Emption Rights

Pre-Emption Rights, also known as pro-rata rights, ensure that existing shareholders have the first opportunity to buy new shares during a capital raise, allowing them to maintain their percentage of ownership in the company and prevent dilution. This right is crucial for preventing the dilution of shares when new investments are made. For founders, managing pre-emption rights effectively can help avoid shareholder disputes and ensure fairness in how new shares are distributed among existing stakeholders.

4. Drag-Along and Tag-Along Rights

Drag-Along Rights allow majority shareholders to force minority shareholders to join in the sale of a company. This right is crucial when a buyer is interested in purchasing 100% of a company and ensures that minority holders cannot block a sale that has the support of the majority of shareholders. Conversely, Tag-Along Rights protect minority shareholders by giving them the right to join a transaction if a majority shareholder sells their stake, thus ensuring they receive similar offer terms and are not left at a disadvantage.

5. Directors and Observers

Investors might negotiate for the right to appoint Directors or Observers on the company’s board. Directors have significant power as they vote on major company decisions, such as budget approvals, executive appointments, and strategic direction. Observers, while not having voting rights, can attend board meetings and provide input, offering investors insights into the company's operations without direct decision-making power. For founders, it’s vital to understand how these appointments can influence the company's governance and align with long-term strategic goals.

Understanding and negotiating these investment legal terms thoughtfully can empower founders to maintain control over their company while securing the funding and confidence of investors. Each term has its nuances and implications for the power dynamics between founders and investors, making them critical elements of any investment negotiation.

Accelerate Law provides strategic and legal advice to startups end-to-end through angel investment rounds and VC funding rounds, which includes supporting with SEIS and EIS matters, flexible funding for example through Advanced Subscription Agreements, and drafting and negotiating investment terms from term sheets through to completion. Accelerate Law also specialise in EMI Schemes for startups. Contact us here to find out more.