Raising a venture capital (VC) round is a big step for any startup. It means investors believe your company is “venture-backable” (i.e. has the potential to grow rapidly and deliver a high return on their investment) and want to help it grow. But this also means dealing with some complex legal agreements and positions. Here’s a simple 9-point guide to help you understand what’s involved.

Key Documents in a VC Round

When you raise money from VCs, you’ll encounter several important documents, including the term sheet, shareholders' agreement, and articles of association. These documents outline the terms of the investment. While VCs usually prepare these, having your own term sheet to show them as part of your pitch set-up can demonstrate that you’re organised and know what you want and have thought this through. Working with an experienced lawyer can be helpful here, to ensure your position is optimised and nothing is missed.

Preferred Shares and Investor Rights

VCs typically get preferred shares, which give them special rights. These shares often come with a 1x liquidation preference, meaning VCs get their money back before other shareholders if the company is sold. They also come with anti-dilution rights, protecting the VCs' investment if the company issues more shares later at a lower price than the price the VC originally invested at. Understanding these terms is crucial because ultimately they affect how much equity you hold in your company, and therefore how much control you have over it and your financial outcomes with it.

Founder Commitments and Vesting

VCs often want founders to commit to staying with the company from investment to exit. This is done through a process called reverse vesting. Even though you own your shares from the start, you earn the right to keep them over time, so if you leave early, you might have to give some shares back. For example, if you have a 5 year reverse vesting schedule and you leave after 2.5 years, then you would need to return half of your shares. This encourages founders to stick around and continue building the company​​. There are different reverse mechanisms that you should discuss with your lawyer at the time of the investment round.

Maintaining Equity Percentages: Pre-Emption Rights

Pre-emption rights help existing shareholders keep their ownership percentage when new shares are issued. In an investment round, this means shareholders have a right (but not an obligation) to participate and invest in the round. This is important because it means shares can’t be issued arbitrarily to other shareholders’ disadvantage (e.g. 1,000,000 shares to the founder for nominal value). It is about ensuring there is fair treatment. However, in a VC investment round, it is also common for these pre-emption rights to be reserved only for the largest investors.

Having a Say: Investor Consent Rights

Investor consent rights mean that all or a select group of major investors need to approve certain big decisions, like issuing more shares, borrowing funds, selling or closing the company, or changing the business model. While this can feel like losing some control, it protects investors from decisions that could harm their investment​​. It is standard to have a list of these matters in any set of investment documents. The negotiation is typically over which points are included in this list, and therefore the number of things which the management team (typically the founders) need to get investor approval for.

SEIS/EIS Tax Reliefs

Typically, VC funds do not qualify for SEIS/EIS tax relief schemes as they are targeted at individual investors, but there are SEIS/EIS funds, which collate money from eligible angel investors so these benefits may still be available if seeking VC investment. If taking money from an SEIS/EIS fund, you should ensure you have advanced assurance in place for the schemes before completing the round.

The Process and Timeline

Closing a VC investment round takes longer than earlier funding rounds (e.g from Angels). It typically takes 6-8 weeks to fully close, involving detailed checks and negotiations. This can feel intense, but it’s part of securing a strong investment. With a VC investment round, you would typically work closely with a lawyer to lead and project manage the process with you end-to-end, in particular as your VC investor will likely also appoint lawyers to do the same and this will help you keep a balanced playing field.

Beyond Money: Additional Benefits

VCs bring more than just money. They offer valuable connections, introductions, and a reputable brand. These can help your business grow faster and open new opportunities - but it might not be offered to you on a plate, you need to actually ask and proactively leverage these additional benefits.

Being Prepared: Strategic Planning

Stay strategic and proactive during the process. Don’t rush into agreements. Understand the long-term effects of each term and ensure they’re fair, with advice from a lawyer during the process. Avoid harsh terms like high liquidation preferences, which give investors two or three times their investment back before others, or full ratchet anti-dilution provisions, which can significantly dilute your ownership if new shares are issued at a lower price.

Raising a VC round involves navigating some complex but important legal aspects. By understanding these key points, you can confidently secure an investment that not only provides funds but also sets you and your startup up for future success.

Accelerate Law provides flexible strategic and legal support 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.