In an earlier guide on raising series A capital in Southeast Asia, we discussed the key series A terms.
In this second guide, we talk about closing the deal and follow-on financings. We also look at the option of venture debt financing.
main transaction documents
Once you have agreed and signed your term sheet, the next step is to prepare the more detailed and legally binding investment documents. In a perfect world, where you have a well drafted term sheet covering all of the material terms of your deal, this would be a largely mechanical exercise for the lawyers to prepare the full investment documents. In reality, there is often additional negotiation at this stage to address gaps and the finer details of the deal.
Southeast Asian series A transaction documents are fairly standard – particularly if your company is domiciled in Singapore. The documents will usually include:
- a subscription agreement which sets out the mechanics and terms of the investment, the conditions to be satisfied before closing, and any representation, warranty and indemnity to be given to the investors by the company or founders (or both)
- a shareholders’ agreement which contains rights and obligations relating to the governance of your company (e.g. information rights, such as receipt of financial statements and quarterly updates) and investor protections going forward
- an updated constitution which, amongst other matters, sets out the terms attaching to the preference shares and mirrors certain parts of the shareholders’ agreement
- a disclosure letter in which you list out all general and specific disclosures against the representations and warranties set out in the subscription agreement.
signing the documents
Often negotiations on a series A investment round are led by one or two of the larger investors. But, remember that all series A investors will also need to sign the documentation, along with all existing non-founder shareholders and any noteholders (whose convertible notes will most likely convert on closing). While most seed investors see the upside from the new funding round and will happily sign the documents, it pays to bring them up to speed at term-sheet stage and provide them with plenty of time to review final documents. This avoids surprises and helps manage expectations.
Conditions precedent is a term used to describe all of the actions that need to happen after the signing of your investment documents but before the deal completes and the funds are received. These conditions are usually included in the term sheet and (in more detail) the subscription agreement. Aside from the corporate authorities discussed below, they often include actions to tidy up issues found in due diligence. So the cleaner your company, the fewer conditions precedent you are likely to see, and the shorter the time to close and receive funding.
Most subscription agreements will include a long stop date by which the conditions precedent must be completed. The person who benefits from the conditions (usually the investor) can choose to waive any condition which is still to be performed, extend the long stop date (if one is stated), or cancel the investment. A typical long stop date is 30 days following the date of the subscription agreement unless more complex conditions are included (e.g. regulatory approvals in jurisdictions such as Indonesia can take several months).
A series A investment transaction in Southeast Asia will require a variety of corporate authorisations or approvals. As with a seed funding round, directors’ and shareholders’ resolutions will be required to approve all of the transaction documents.
Assuming your company is domiciled in Singapore, this usually needs to cover:
- approval and execution of the subscription and shareholders’ agreements and the disclosure letter
- issue of the subscription shares to the investors
- appointment of the investor director(s) to the board
- approval and execution of service agreements if founders are to become executive directors of the company
- appointment of corporate representatives to execute on behalf of any corporate shareholders
- adoption of an employee share plan, or allocation of the share or option pool.
Normally, you will need to obtain waivers of any pre-emptive rights from existing shareholders to enable the series A deal to proceed.
In most cases the completion date for an investment is on or around the date that the conditions precedent are satisfied or waived.
The subscription agreement will set out the actions to be taken by each party on the completion date. A typical list of completion requirements includes:
- delivery to the investor of the signed corporate authorities
- the new shareholders’ agreement, signed by the company and all existing shareholders
- a certified (i.e. signed by a director) copy of your company’s share register recording the investors as shareholders in your company
- any other deal specific deliverable document.
Payment of the investment funds into the nominated company account, and delivery to the company of:
- the new shareholders’ agreement, signed by the investors
- the written consent of the investor (or the investor’s nominee) to act as a director of your company.
Post-completion, you will need to update your company registers and your records at the relevant regulatory body (e.g. in the case of Singapore, the Accounting and Regulatory Authority) to reflect the issue of the new shares to the investors, the appointment of any investor nominated director, the adoption of the new constitution of your company, and any other matter required by that body.
employee share incentives
At series A stage, if not already in place, most companies implement an employee share option scheme (ESOP). This pool is for founders and employees, and options under the scheme will be granted by the board. The ESOP pool is often set at 10-15% of the fully diluted share capital.
Options are a great way to incentivise employees but the ESOP terms can vary. Aside from when the shares vest, think about:
- whether the ESOP should include good/bad leaver provisions or KPIs
- how the vesting period may accelerate on a liquidity event. Generally, to exercise the options, the option holder must sign a deed confirming that he or she will be bound by the current shareholders’ agreement. If that agreement doesn’t include a drag-along right, this is often added to the ESOP documentation.
We suggest holding off putting an ESOP in place until after the series A has closed (and often it is a requirement to implement within 90 days). This means the handling the ESOP won’t distract from closing the investment round.
To implement an ESOP, the shareholder’s agreement and constitution will need to authorise the granting of ESOP options and issue the associated shares on exercise, outside of any restriction on issuing new shares. Also, investors may want to approve the terms of the scheme before its implementation. This is fine, but the allocation of the options should remain at the sole discretion of the board (who are the best persons to determine who is worthy of participating).
An ESOP is not the only way employees can be incentivised, e.g. employee share ownership (ESOW) plans allow employees to directly own or purchase shares in the company.
For companies which are incorporated in Singapore, if an employee is granted share options under an ESOP by an employer, he or she will be taxed on any gain or profit arising from the exercise of the share option. However, an employee who is granted shares under an ESOW is subject to tax on any gain or profit only when the ESOW plan vests on the employee.
There is a lot of publicly available information on ESOPs, certainly for Singapore domiciled companies, e.g. the Singapore Ministry of Finance has provided information on Stock Options and Awards and, on the Inland Revenue of Singapore (IRS) website, there is a guide to work our your taxes.
Successful companies may be supported further by existing and new investors. Each time additional funding is raised, the follow-on shareholders usually expect to be issued a new class (or series) of shares carrying preferential rights to the highest class of shares on issue. So you may need to issue series B or series C preference shares in the future. These follow-on rounds can take businesses beyond development to the next level and can end up being large investments at high valuations.
The terms of series B and follow-on investments are similar to those on a series A round. Often, these investments are led by the same VC funds as the previous round. However, one key difference can be the bargaining power. Your series A investment round may have been negotiated by a lead investor who retained much of the control in its sole capacity. On subsequent rounds, there may be several major investors who will end up holding similar percentages of the total equity. The result is that investor veto rights are often flattened out so that approval is given by a specified majority of all preference shareholders. This is good for the company as no one investor can then block key decisions as the company approaches the key stage of its growth.
With your business now established, there are good grounds for founders to ask that their personal liability (if any) under the investment documentation fall away. Often, representations and warranties at series B are given by the company only. This means that founders can focus on growing the business without concerns about ongoing personal risk.
In Southeast Asia, new VC funds are emerging that specialise in this later stage investing – see Techcrunch’s article on Eduardo’s Saverin’s new fund. If you get to series C and beyond, investment banks, hedge funds, large corporates or private equity firms may also accompany the more typical VC investors. The terms on these deals may be more like a private equity deal with a clear focus exit.
Venture debt is another form of follow-on financing which is becoming increasingly popular in Southeast Asia. Some financial institutions in the region have set up schemes to finance startups, including Singapore’s DBS and OCBC. Temasek’s Innoven Capital and the Singapore government agency Spring Singapore have looked at similar schemes. Venture debt typically supplements an equity round by providing additional capital – but with the upside of limited further dilution for companies. It is senior debt so it takes priority over any other debt that your business may have and includes the issue of warrants (a right to subscribe for shares in the future at a fixed price).
Venture debt is different to convertible instruments which were discussed in our guide to raising seed capital in southeast asia – structure and terms, i.e. unsecured debt which converts into equity on the next financing round. Venture debt doesn’t convert but will typically be secured against the assets of the company. e27’s blog post on venture debt has a good analysis of venture debt transactions.