In February 2023, the BVCA brought out their latest set of Series A model investment documents (‘the Model Documents”).
Interestingly, the BVCA explicitly states that they are not suitable for seed and earlier rounds. Despite this, I have observed their growing use in seed (and even pre-seed) investments. In this short article I’ll highlight some key issues Founders should look out for in these Model Documents and explain why they might not be a suitable template for seed and pre-seed investment rounds. For reference, you can find the suite of documents here.
Definition of “Investors” and “Major Investors”
From the outset, the Model documents define “Investors” as those owning “Series A” shares. As you would imagine, a vast swathe of control/consent and information rights are reserved only to those meeting this definition and usually exclude the Founders and any existing investors.
In addition, the documents also introduce a hierarchy with the concept of “Major Investors” who are defined as “Investors” owning above a certain percentage of the company. These Major Investors are granted specific control rights, such as pre-emption on new share issues and share transfers, which are not extended to other shareholders (more on this below).
The Case for Ordinary Shares and Consensus Driven Decision-Making
I always view early stage investing as a partnership with Founders. For this reason, I prefer to see pre-seed and seed investors coming alongside Founders in Ordinary Shares to maintain that sense of parity.
Furthermore, whilst I agree that investor consents form an important check and balance, I would advocate for a more consensus driven approach which includes the Founders, such that those consents require a sensible percentage of the overall equity to vote in favour. To avoid an unwieldy process, those consents should be kept to a short list of major matters to stop unfair prejudice of investors. Operational consents, like spending or debt decisions above certain threshold, can be left to an Investor Director or Observer (note to self: this person should be wisely chosen!).
Pre-Emption Rights
One of the biggest points of contention in the Model Documents is how pre-emption rights are dealt with. Here the statutory pre-emption rights (for new share issues) that exist in the Companies Act 2006 are permanently disapplied. Instead, pre-emption rights are reserved to Investors or Major Investors.
Whilst Founders often lack the funds to reinvest meaningfully in their own company, the idea of excluding them outright doesn’t seem right. The same issue arises where angels have backed a company in the early rounds. There is an issue of basic fairness but more than that: we all know that a start-up’s journey can be a rollercoaster that may well include some – shall we say – “difficult” terms in a funding round. Therefore, both an investor’s and Founder’s key protection with respect to the terms imposed by later investors is their pre-emption right to participate in later rounds. If that’s gone, the risk-reward for angels looking at pre-seed and seed is shifted materially.
In my own experience, this is the biggest issue with the Model Docs and where the most time is spent trying to negotiate a more equitable position. My personal view is simple: pre-emption rights are sacred!
Other Key Clauses to Watch
Founders should carefully review several other provisions in the Model documents, including:
- Anti-Dilution Protection: the Model Documents include broad-based anti-dilution provisions as standard.
- Pre-Emption Rights on Share Transfers: Founders should look carefully at matters such as pre-emption rights on share transfers as well as who has (and doesn’t have!) Co-Sale rights
- Drag-Along threshold: Consider whether the threshold % aligns with the post-funding realities of the cap table.
Final Thoughts
The growing use of the Model Documents in the very earliest funding rounds has been interesting to observe. However, as the BVCA itself states, these documents are not designed for this purpose and I do tend to agree.
Instead, for seed and pre-seed investments, Founders and investors alike should perhaps see these documents as a starting point and be prepared to negotiate terms that better reflect the realities of an early-stage partnership. Alternatively, there are many other sources of documents for pre-seed and seed funding rounds.
