How to close a deal faster

Can you walk us through the process of closing an investment with a Bulgarian VC fund backed by public money (e.g. Fund of Funds)?

Ani Stancheva: From legal perspective the main steps are the following: 

Although not legally binding, the Term Sheet is not some meaningless piece of paper. This document is the starting point of negotiations between the parties and sets reasonable expectations about the actual terms of the investment round. Therefore, it is important to correctly understand the meaning of the offering terms and to talk them over before signing the Term Sheet. If the planned investment round includes many investors, we are normally involved in the process even at that early stage. 

It is important to note that most VC Funds in Bulgaria are backed up with EU funds so their activity should be compliant with the Public Procurement Act, Staid Aid rules, Regulations on ESI Funding, etc. So the first thing we do is to do this compliance check by requesting the beneficiary company to provide evidence and declarations for eligibility. For example, whether the company falls within the definition of SME, whether it is a ‘company in difficulty’, whether it has received financial aid before, in which NACE sector it operates, does it have a close relation with Bulgaria, etc. 

  • Legal Due Diligence Report

It is essential for the Funds to take an informed decision about the businesses in which they invest so the legal DDR is a must. It is focused (at the very minimum) on the review of: 

  • general corporate history and status of the company; 
  • important material contracts and agreements with banks and other creditors;
  • Agreements on acquisition/disposal of material assets and commercial agreements;
  • Share purchase agreements, convertible loans, and other contracts for the acquisition of share capital;
  • Employment issues;
  • Intellectual property;
  • Litigation proceedings.
  • Internal Resolutions and Documents of the Fund

Following the mandatory compliance check and DDR we draft the Funds’ internal documents such as Eligibility Report and Investment Committee Resolution. It is important to have a finalized Cap table at this point because the Investment Committee shall take a decision as regards the number of the shares to be subscribed, the price per share, % that will be acquired in the Company’s capital, co-investors, etc. In the cases of our clients the Investment Committee Resolution shall be presented to the Funds’ investors as part of the Drawdown documentation, and it should be as specific as possible regarding the conditions of the planned investment round. 

  • Submission of a Drawdown notice

In the context of publicly financed VC Funds the drawdown notices look like mini tender procedures. They require the submission of numerous documents and standard forms under the Operational Agreements of the Funds. The idea is that the Fund Managers shall prove before the Fund of Funds that they have carried out all the necessary eligibility checks and they have an official Investment Committee Resolution. So in order to submit a drawdown we must double check and submit all documentation accumulated during steps B-D above. Furthermore, the Fund of Funds had the right to request additional information or explanations regarding eligibility. The drawdown process is thus way more complex than the one typically known in the VC industry.

  • Investment Agreement and Negotiations 

Normally, we are trying to overlap processes so that we can manage to close the investments as quickly as possible. So, we draft the Investment Agreement (Shareholders Agreement) in parallel to the preparation of the Drawdown notice. Thus, once we submit the drawdown notice we can immediately start with the negotiations process while waiting for the feedback from the Fund of Funds. The length of the negotiations really varies from company to company, but we could say that it goes way more smoothly when the parties are respecting the arrangements of the Term Sheet and are not trying to re-negotiate terms that were already discussed and agreed upon. While it is true that the Term Sheets are not binding, they set some reasonable expectations for both parties and are key factors in the negotiation process. 

When we have a final draft of the Investment Agreement and all its terms have been agreed upon by the parties we are preparing the documents for capital increase of the company – the new Article of Associations, Resolutions for capital increase, etc. Normally, this step goes very fast as these are standard documents. We rarely have some discussions regarding the content of the Articles of Association given the fact that it reflects the terms of the Investment Agreement. 

Signing of the Investment Agreement and Corporate documents – our favorite part of the process.  Once everything is signed by all parties, the Funds are transferring the investment amount (shares subscription price) to the company’s bank account and the capital increase shall be registered in the Commercial Register. 

Lawyer Ani Stancheva
Ani Stancheva, Senior Associate at Georgiev and Kolev Law Offices

Founders often complain about the long procedure of getting approval from the Fund of Funds? Is there something they can do to prepare better and reduce the time at least a bit? 

Ani Stancheva: The process indeed could be quite lengthy, but often it is in fact slowed down by some ‘minor’ errors on the part of the Founders. Normally, these setbacks tend to happen in the eligibility check and DDR phases. It happens quite too often that the Founders do not disclose all relevant information or that they submit incorrect information. 

In most cases this is due to the lack of understanding of the eligibility requirements. We have made a lot of effort to facilitate the Founders in this process. We even drafted some explanatory instructions, but the truth is that some of the mandatory documentation might require the assistance of a legal consultant or the advice of an accountant. This is specifically the case when the company has a more complex capital structure or is part of a group. 

Another thing that could slow down the process are last minute changes in the Cap Table, change of co-investors or addition of new investors. As already explained, by the time the Investment Committee takes its decision to approve the investment, all details regarding the investment round should be cleared out. Any change means a new Resolution of the IC and if the latter is already submitted to the Fund of Funds, it means corrections in the Drawdown notice. 

Do you have any recommendations when it comes to the negotiation of legal terms between VC funds and startups? 

Ani Stancheva: After more than sixty-five investments we may have lots of recommendations but more generally speaking we would say that it is important to keep in mind that the equity investment is not a donation. The goal of investors is ultimately to achieve some return on their investment and to secure some opportunities for a profitable exit. Therefore, Founders should not push back entirely against standard VC terms like Right of first refusal, Tag Along, Drag along, Liquidation Preference, etc. 

There must be a rationale for any deviation from standard VC terms as they are usually expected by CEE Funds. Moreover, the Funds are being transparent about these terms from the beginning as they are clearly set out in the Term Sheets. Here comes the importance of a good legal counsel who could propose amendments to standard clauses making them more balanced and protecting the interest of the Founders. Simply, there is a difference between amendments propositions and a general statement of disagreement. In our view, the Founders should cut back the Do-it-Yourself approach and seek legal advice during the negotiations process.

What are the most frequent and harmful legal mistakes startup founders make in the pre-seed/ seed stages that make their lives difficult later when they try to scale? 

Lawyer Vanina Popova
Vanina Popova, Associate at Georgiev and Kolev Law Offices

Vanina Popova: The most common that come to mind are mistakes at the very incorporation of the company – wrong entity type, wrong country, wrong capital distribution between founders. Other problems might be for example the lack of assigning of IPR from founders/employees to a startup, not updating the capital structure and cap table, calculation mistakes in share purchase operations, etc.   Frankly speaking, there are too many ghosts that might be found in the company’s drawers. 

Can you give us an example of how costly it would be to fix such a mistake later rather than preventing it all together? 

Vanina Popova: Mistakes within the incorporation might sometimes require incorporating a new entity and liquidating the existing one. Incorrect distribution of capital, for example, would require share transfers, capital increase, capital restructuring. 

IPR is another problematic issue for Bulgarian startups. Most commonly we have founders and early employees who have failed to sign UP assignments at the incorporation or when they joined the company. Another scenario could be that the startup is part of a corporate group but there are no legal arrangements between the different companies as regards the IPR. Until the startup could prove ownership over the IPR it is not investible. 

These are only a few traps that early-stage founders may fall into. The cost for resolving these issues may vary depending on the specific situation. However, even if the mistake is not too costly for the Founders, it may deter the potential Investors or in the best-case scenario it will slow down the whole investment process and make it even more complex than it already is.

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