Brexit, the US elections, blockchain, Cyber, AI and IoT are just a couple of interesting (legal) topics that have kept us busy this past year. As we approach the end of 2016, it is worthwhile reflecting on the events that have kept us busy this year. Besides these topics, the start-up industry has also received significant attention. Data* shows that the European continent is becoming an increasingly popular place for entrepreneurs to start their business, especially for tech start-ups. On the M&A and funding front, this year could be a record year in terms of capital invested and the number of tech deals throughout Europe. There were even twice as many tech exits (or should we call them te(ch)xits) in 2016 as compared to 2015 and 2014. Looking at the numbers it appears that there has actually never been a better time in history to start a tech company in Europe.
While listing these encouraging statistics, we realize that there are still many challenges for the European start-up (tech) ecosystem. From the perspective of a lawyer based in Europe, it seems somewhat strange to talk about a "European" start-up ecosystem as Europe consists of many countries with their own (sub)cultures - and not unimportantly - many differences in terms of rules and regulations. Although rules and regulations differ throughout Europe and comprehension therefore remains a challenge, there seems to be a certain degree of convergence if we look at the key funding terms of investments from a legal point of view.
On 16 November 2016, the results of a research on key funding terms included in term sheets in Europe, was presented during the IBA Start-Up Conference in London. The term sheet is the most important legal document when discussing and negotiating investment terms in start-ups and scale-ups and often determines the final deal structure. Therefore, we have listed the most interesting findings of the research below without getting overly "tech"-nical.
A certain degree of convergence exists in Europe as to the relevant issues when negotiating a term sheet such as capital structure, governance, additional funding, founder/leaver arrangements, transfer restrictions, exit arrangements and restrictive covenants. Differences, however, exist with respect to technical implementation, local law requirements and restrictions and the maturity and level of sophistication of the respective market/ecosystem. In Europe, term sheets are in general non-binding with the exception of clauses such as ¬confidentiality, exclusivity, governing law etc.
Due diligence vs Representations and Warranties
Representations and warranties are often not dealt with in detail at the term sheet level. Participants widely agreed that the primary purpose of representations and warranties is to facilitate disclosures and diligence on the part of the founders, rather than to act as an actual basis for claiming damages after closing. To some extent the representations and warranties seem to (partly) substitute due diligence. In series A rounds due diligence investigations are performed in a very focussed manner and often specifically focus on intellectual property. Warranty and indemnity insurance does not seem to play any role in (early stage) funding rounds.
The governance set up post-investment is - not surprisingly - the subject of heated debate throughout Europe. Lawyers play an important - if not central role - in guiding these discussions and making sure that the legal documents adequately reflect the commercial reality. Solutions proposed to balance the interests of founders and investors are, amongst others, (i) careful composition of the board and required level of investor majority, (ii) manage expectations in terms of realistic thresholds/ reserved matters, (iii) limit consent matters to those not contained in or deviating from an approved budget and most importantly (iv) review, revisit and amend (if needed) approval requirements and thresholds.
If we look at exit provisions in term sheets and shareholder agreements, it becomes apparent that actual exits rarely match the intended process/ time line agreed upon in the transaction documentation. For this reason at term sheet stage it is sufficient to have a general statement that parties contemplate an exit within a defined period. Participants of the research emphasized the importance of practical drag and tag along clauses as an exit-trigger. Detailed exit provisions, such as registration rights, piggy back clauses, are mostly seen in a US context.
Another interesting take away from the session was the fact that in Series A transactions the term sheet is often signed without the involvement of lawyers. Eventhough the term sheet is non-binding in nature, we highly recommend that parties seek legal advice when it comes to negotiating the term sheet as it often determines the final deal structure between parties and is the first steps towards a successful relationship between founder and investor.
Want to learn more? The lawyers of Van Doorne are highly experienced in advising on tech deals and (of course) term sheets and are ready to assist you. The Van Doorne TMT team wishes you Happy Holidays and a prosperous 2017!