Expert insight: From start-up to Series A
In our latest expert insight piece, Nathan Guest, Corporate Partner, Technology & Life Sciences (Head of Technology) at VWV, guides us through what every start-up should know about seeking investment.
From start-up to Series A: How to get investment ready
Start-ups (including spin-outs), scale-ups and the talented people they employ are a hugely significant driver of innovation in the UK life sciences sector. However, developments in science and technology made by those companies will not survive the journey to successful commercialisation without appropriate funding.
Early stage funding typically comes in two forms – grant funding and equity funding. However, grant funding often requires some level of match funding, so equity fundraising is on the critical path for the majority of start-ups and scale-ups we work with. Fundraising processes are challenging and distracting enough – heading into one without being properly prepared rarely ends well!
This article focuses on ‘investment readiness’ from a legal perspective. A company seeking to raise money will also need to spend considerable time preparing a slide deck and/or business plan, financial projections and a persuasive pitch – but that is for another article!
Investor due diligence
Before a venture capital investor commits itself to a funding deal, it will generally carry out due diligence investigations to satisfy itself that that there are no material issues which could impair or prevent the business plan from being fulfilled, or which might suggest that the valuation is too high. They and their lawyers will need answers to a number of questions (an institutional investors will typically ask many more questions than angel investors will). Do you own what you think you own? Are you regulatorily compliant? Who is working in the business and on what terms? Life sciences investors will be as demanding on these legal points as they are on your R&D and commercial plans, so you need to be prepared.
The due diligence process can take a lot of time which will inevitably have an impact on the founders’ ability and capacity to do their day job. To limit the distraction that due diligence can cause, we advise that companies who are seeking to raise growth capital undertake an ‘investment readiness’ legal audit in advance of investor discussions. This is particularly important for companies seeking to raise an institutional round of investment.
The ‘investment readiness’ process involves working through a questionnaire on the legal areas that an investor will focus on. These areas typically include:
- Intellectual property – This is usually one of the most important areas for life sciences companies and one where the most complications can arise – particularly for spin-outs. If the founders were working for a university when the initial idea arose and was developed, who owns the resulting intellectual property? If it is the university, has it been validly assigned or licensed in? Who will own any improvements? How will “know how” be addressed? Is confidential information adequately protected so that the company does not lose rights to patents and know-how? These questions are even more complex if there are academic founders who remain employed by the University but are engaged as consultants to the company. Other areas that can enhance value are applying to register the brand and securing relevant domain names.
- Contracts – If key personnel are acting under consultancy agreements, then the terms of these need be carefully reviewed. Unless there is a written agreement that confirms otherwise, IP developed by a consultant or contractor is very likely to be owned by them. It is imperative that the arrangements are properly documented so show that the company owns or will own the IP (although, as referenced above, there will be other considerations if the consultant is an academic).
- If the company is post-revenue, an investor will also want to know that the company’s relationships with important customers are properly documented. If you already have a product or service going to market, are the terms and condition properly protecting your rights and information?
- Employment – If the company has employees, the investor will want to see evidence that they have been properly engaged and statutory requirements have been met. Founders of life sciences companies will often have been working on an informal basis without a full employment contract and so pre-investment is good time to get these arrangements on a clear legal footing. This also links to IP protection – a well-drafted employment contract will make sure that anything created or developed by the employee during the period of the employment would belong to the company.
- Shareholdings, structure and constitution - Who owns the shares in the company? An investor will review the company’s statutory books, to ensure that they are consistent with the Companies House filings and they will also want to review the articles of association and any shareholders’ agreement or investment agreement to check whether any existing investors can block a new investment. If you have set up share options or other equity incentive schemes for key employees (or wish to do so) then this should be reviewed, before implementation, to ensure they work and do not get rise to avoidable income tax charges.
- Data protection - An investor will need to be satisfied, particularly where the company deals with personal data, that the correct legal safeguards are in place as regards the use, storage and sharing of data. A life sciences company will often be dealing with medical data, which is subject to even more stringent controls, and so ensuring compliance is crucial.
- Financial promotions – there is significant legislation that governs how companies in the UK may lawfully raise investment. You will need to take legal advice on the steps that need to be taken to avoid or mitigate the risk of inadvertently committing a civil and criminal offence by getting this wrong.
Carrying out a legal investment readiness audit will:
- require management to compile key documentation so that it is organised, ahead of the investment negotiations beginning in earnest
- give the company and its lawyers the opportunity to identify and, hopefully, rectify any issues that might otherwise weaken the company’s bargaining position, including on valuation, or even cause the deal to abort; and
- give the company greater confidence that there are no “skeletons” in the company closet.
When it comes to raising capital, being ‘investment ready’ can make a huge difference to the ease at which the investment proceeds, the time the deal will take to conclude and will provide founders with the best protection against the investor chipping away at the valuation.
At VWV we have a team of specialist lawyers dedicated to supporting start-ups, spin-outs and other emerging technology and life sciences companies that are created to develop and commercialise innovative technologies and scientific developments. If you would like to discuss what legal investment readiness might mean for you, please contact Nathan Guest.
Nathan Guest – Corporate Partner, Technology & Life Sciences (Head of Technology) – VWV
Nathan is a corporate lawyer with more than 20 years’ experience of advising clients on private equity, venture capital, M&A and management buy out transactions. Although he acts for UK and international corporates and some institutional investors, the vast majority of his and his team’s clients are technology and life sciences start-ups (including University ‘spin-outs’), scale-ups and other high-growth technology and life sciences companies. Nathan has co-founded and led several “lawyer-in-residence” programmes for UK tech and life sciences incubators and has sat on numerous advisory boards during his career. Nathan leads a team of 40 specialist lawyers who focus on helping these emerging tech and life sciences clients to navigate the many potential legal pitfalls and impediments to scaling their business. In particular, Nathan has considerable experience of advising clients on angel and institutional venture capital fundraising deals, including corporate venturing deals, and in preparing for them. Having a significant network of contacts, Nathan is also happy to provide assistance with introducing clients and contacts to other businesses, professional advisers and key contacts who may be able to help them – whether in connection with an actual or potential transaction or ongoing commercial matters. For more information on Nathan and what his clients say about him and his team, please visit https://www.vwv.co.uk/lawyers/nathan-guest.