Can You Accept Investment Before Your Shareholders Agreement Is Ready?

An investor is ready to transfer the money, but your Shareholders Agreement is still being finalised. Rather than delaying the investment - and potentially slowing down funding your business could really use - you might be tempted to accept the money now and sort out the final documents afterwards.

Can you do that?

Potentially, yes. Your Shareholders Agreement does not always need to be finalised before an investment can move forward. However, that doesn’t mean you should simply accept the money with nothing else in place.

The documents you need will depend on how the investment is structured, particularly whether the investor is receiving shares now or has a right to receive shares later.

What Actually Needs To Be Agreed Before You Take The Money?

All shareholders hold equity in a company, but not every investor necessarily becomes a shareholder as soon as they invest.

For example, an investor subscribing for shares becomes a shareholder once the relevant steps for the issue are completed and they are entered into the company’s register of members. Other investment structures can involve providing funds now, with the right to receive shares at a later point.

This distinction matters because a Shareholders Agreement is only one part of documenting an investment.

Before money changes hands, the company and investor should be clear about the key terms of the deal. Depending on the investment, this could include how much is being invested, what the investor receives in return, the number and class of any shares being issued, the price or valuation being used, when the investment will complete and any conditions that need to be met first.

If the investment will convert into equity later, the parties will also need to agree on how and when that conversion can happen.

These terms do not necessarily all belong in the Shareholders Agreement. Some may instead be recorded in a Share Subscription Agreement, an Advanced Subscription Agreement, SAFE, convertible note or another document suited to the particular transaction.

Getting these terms clear before accepting the funds can help avoid a much harder question later: what exactly did the investor pay for?

A Term Sheet Is Not The Same As The Final Investment Documents

Perhaps you already have a term sheet setting out the proposed investment. Does that mean you are ready to take the money?

Not necessarily.

A term sheet is commonly used to record the main commercial points the parties have agreed on while the final investment documents are being prepared. For example, it might cover the amount being invested, the proposed valuation, shareholding, investor rights and any major conditions attached to the deal.

However, a term sheet does not automatically replace the final investment documents.

Many term sheets are intended to be largely non-binding, with only particular provisions - such as confidentiality or exclusivity - intended to have immediate legal effect. However, this depends on how the term sheet has been drafted and what the parties have actually agreed.

Before treating a term sheet as the basis for accepting funds, check what it actually says. Agreeing on the headline numbers does not necessarily mean all of the terms required to complete the investment have been settled.

What If The Investor Is Receiving Shares Immediately?

If an investor is giving the company money in exchange for new shares now, the investment itself should be properly documented even if the final Shareholders Agreement is still being worked on.

A Share Subscription Agreement can document the investment transaction. It can cover matters such as how many shares the investor is subscribing for, what class they will receive, how much they are paying and what needs to happen before the investment completes.

This serves a different purpose from a Shareholders Agreement.

The subscription agreement deals with the investor coming into the company. The Shareholders Agreement deals more broadly with the ongoing relationship between the shareholders, including matters such as voting, management, share transfers, exits, deadlocks and other shareholder rights.

For some investments, both can be dealt with together through a Subscription and Shareholders Agreement.

Whichever approach you take, issuing shares involves more than simply receiving the investor’s payment.

Australian companies generally have flexibility to determine the terms on which shares are issued, but the issue still needs to comply with the Corporations Act 2001 (Cth), the company’s constitution or applicable replaceable rules, existing share rights and any relevant shareholder arrangements.

This is why your existing company documents should be checked before promising an investor a particular shareholding.

What About Existing Shareholders?

Bringing in a new investor can affect the people who already own the company.

For proprietary companies, section 254D of the Corporations Act is a replaceable rule dealing with pre-emption on new share issues. Where it applies, before issuing shares of a particular class, the directors generally need to first offer those shares to the existing holders of that class in proportion to their existing holdings.

However, replaceable rules can be modified or displaced by a company’s constitution. An existing Shareholders Agreement may also contain its own rules around issuing new shares, pre-emption rights or obtaining shareholder approval.

This means you should not assume that agreeing with the new investor is enough. The company may also need to deal with rights held by its existing shareholders before the investment can proceed.

What Other Steps Are Involved In Issuing The Shares?

Once the investment terms are agreed, the company still needs to properly approve and record the share issue.

Depending on the company’s constitution, existing agreements and the particular transaction, this can involve board resolutions, shareholder approvals or consents and dealing with any applicable pre-emption rights.

Directors making decisions about the investment also need to comply with their directors’ duties. This includes exercising their powers in good faith in the best interests of the company and for a proper purpose.

This can be particularly relevant where issuing new shares will dilute existing shareholders or change who controls the company.

Once shares are issued, the company also needs to update its share register. Australian companies generally need to notify ASIC of a share issue within 28 days, and proprietary companies must provide relevant details about the members receiving those shares.

Accepting the investment and issuing the shares should therefore be treated as parts of the same transaction rather than something the company can piece together afterwards.

Do Australian Fundraising Rules Matter?

They can.

Australian companies also need to consider the fundraising requirements in Chapter 6D of the Corporations Act.

A proprietary company generally cannot undertake fundraising that would require disclosure to investors under Chapter 6D, although there are various circumstances where an offer can be made without a disclosure document.

For example, the small-scale offering exemption under section 708 can apply to certain personal offers where the relevant 20-investor and $2 million limits are not exceeded over a 12-month period. Other exemptions can apply depending on the investor and the circumstances of the raise.

Before accepting investment, it is therefore important to check that the way the investment is being offered and structured complies with the fundraising rules that apply to your company.

What If The Investor Isn’t Becoming A Shareholder Yet?

Not every investment involves issuing shares immediately.

Early-stage companies sometimes use a convertible investment structure where an investor provides funds now and receives the right to equity later.

Depending on the raise, this might involve a SAFE (Simple Agreement for Future Equity), Advanced Subscription Agreement or convertible note.

These arrangements do not all work in the same way.

For example, a SAFE generally gives an investor a contractual right to receive equity when an agreed future event occurs rather than operating as a conventional loan. A convertible note generally starts as debt and can convert into equity in accordance with its terms. An Advanced Subscription Agreement can allow an investor to provide subscription funds before a priced equity round, with the agreement setting out when and how the investment will convert into shares.

Using one of these structures can mean the investor does not become a shareholder immediately. It does not mean the investment can remain undocumented.

The agreement should deal with matters such as how much is being invested, when conversion can occur, how the number or price of future shares will be determined and what happens if the expected conversion event does not occur.

In other words, you may be able to postpone issuing the shares. You should not postpone agreeing on what happens to the investor’s money.

Can You Make The Investment Conditional On The Final Documents?

Another option is to agree to the investment without completing it immediately.

For example, an investment agreement can make completion conditional on certain steps happening first.

Depending on the deal, those conditions could include obtaining the required company approvals, dealing with existing pre-emption rights, amending the company’s constitution or finalising and signing the Shareholders Agreement.

This can give both the company and investor more certainty around the proposed investment without issuing shares or treating the transaction as complete before the remaining legal requirements have been dealt with.

If the Shareholders Agreement is nearly finalised, making its execution a condition of completion can sometimes be much cleaner than taking the money first and trying to agree on the remaining shareholder arrangements afterwards.

What If The Investor Has Already Transferred The Money?

Sometimes the money arrives before the paperwork catches up.

Perhaps the investor transferred the funds following a handshake agreement. Maybe there is a term sheet, but the subscription documents were never signed. Or perhaps everyone assumed the Shareholders Agreement could simply be dealt with later.

If this happens, it is important to work out exactly what has already occurred.

Has the company actually issued the investor shares, or has it only received their money? What did everyone agree the payment was for? Are there emails, a term sheet or other documents recording the deal? What number and class of shares were promised? Were any conditions attached to the investment?

The company should then check its constitution, any existing Shareholders Agreement and the approvals and corporate records relevant to the transaction.

If shares have already been issued, it is also important to check that the company’s share register and ASIC records have been properly updated.

What you generally want to avoid is leaving the investment in an uncertain position while the company and investor operate on different assumptions about what rights the investor actually has.

Why Not Just Finish The Shareholders Agreement Later?

It may be possible to complete an investment before the final Shareholders Agreement is signed. That does not necessarily mean leaving it until later is the best approach.

A Shareholders Agreement can deal with some of the most important questions that arise once a new shareholder joins the company.

Who makes major decisions? Does the investor have a right to appoint a director? Are there decisions that require particular shareholder approval? What information can shareholders access? What happens if a founder wants to sell? What happens if the entire company is sold?

These matters can be much easier to negotiate before everyone is already locked into the relationship.

Importantly, becoming a shareholder does not automatically make someone a party to a Shareholders Agreement.

If an investor has already been issued shares, the company cannot simply decide afterwards what contractual obligations that shareholder will have. The investor generally needs to agree to the Shareholders Agreement, for example by signing the agreement or an appropriate deed of accession.

This is one reason it can be safer to deal with the ongoing shareholder arrangements as part of the investment process rather than assuming they can always be sorted out afterwards.

So, Can You Accept The Investment Before The Shareholders Agreement Is Ready?

Potentially, yes.

A pending Shareholders Agreement does not necessarily mean an investment has to come to a complete stop.

What matters is having the right legal framework in place for the investment you are actually accepting.

If the investor is receiving shares now, the transaction may need to be documented through a Share Subscription Agreement or similar investment agreement, alongside the necessary approvals, existing shareholder rights, fundraising requirements and company records.

If the investor is providing money now for equity later, a SAFE, Advanced Subscription Agreement or convertible note may be more appropriate depending on the deal.

Alternatively, the company and investor may agree to the investment but make completion conditional on the final Shareholders Agreement and other documents being signed.

What you generally want to avoid is accepting a significant investment first and leaving everyone to work out what the investor actually receives afterwards.

Getting Your Investment Documents In Place

An investment can involve several legal documents, and they do not all serve the same purpose.

A Share Subscription Agreement can document an investor subscribing for new shares. A Shareholders Agreement can establish the rules governing the relationship between shareholders once the investor is on board.

Depending on the raise, both can also be dealt with through a Subscription and Shareholders Agreement.

For investment that will convert into shares later, documents such as an Advanced Subscription Agreement, SAFE or convertible note may be relevant instead.

The right approach depends on your company, the investor and exactly what has been agreed.

Getting legal advice before the money or shares change hands can help make sure the investment documents, company approvals and shareholder arrangements all work together - rather than trying to fill in the gaps once the investor is already on board.

If you would like a consultation on getting the right legal agreements sorted before accepting investments, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.