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 new shares becomes a shareholder once the share issue has been completed and their name has been entered on the company’s share register. Under the Companies Act 1993, a share is issued when the holder’s name is entered on that register.

Other investment structures can involve an investor providing money now, with shares being issued later.

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, the price or valuation being used, when the investment will complete and any conditions that need to be satisfied first.

If the investment will convert into shares later, the parties will also need to agree on how and when that conversion takes place.

These terms do not necessarily all belong in the Shareholders Agreement. Some may instead be recorded in a Share Subscription Agreement, 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, 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.

Some term sheets are intended to be largely non-binding, with only particular provisions - such as confidentiality or exclusivity - having immediate legal effect. This depends on how the document 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 legal terms required to complete the investment have been settled.

What If The Investor Is Receiving Shares Immediately?

If an investor is putting money into the company in return 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, the class of shares, how much they are paying and what needs to happen before the investment completes.

This serves a different purpose from a Shareholders Agreement.

The Share Subscription Agreement deals with the investor putting money into the company and receiving new shares. The Shareholders Agreement deals more broadly with the ongoing relationship between shareholders, including matters such as voting, company management, future share issues, transfers and exits.

Whichever documents are used, issuing the investor shares involves more than simply receiving their payment.

What Does The Board Need To Do Before Issuing Shares?

New Zealand has specific rules around what the board needs to do before new shares are issued.

Under section 42 of the Companies Act 1993, the board may generally issue shares at any time, to any person and in any number it thinks fit, subject to the Act and the company’s constitution.

However, there are still important requirements around the terms of that issue.

Under section 47, before issuing shares the board generally needs to decide the consideration for the shares and the terms on which they will be issued. The board must also resolve that, in its opinion, the consideration and terms are fair and reasonable to the company and all existing shareholders.

The directors voting in favour of that resolution must sign a certificate recording the required matters.

This is particularly relevant where bringing in a new investor will dilute existing shareholders or significantly change the company’s ownership.

If the company’s constitution restricts the proposed share issue, additional approval may also be required.

This is why the investment documents, company constitution and board approvals should be considered together before the investment completes.

What About Existing Shareholders?

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

Section 45 of the Companies Act 1993 provides default pre-emptive rights for certain new share issues. Broadly, where the new shares would rank equally with or ahead of existing shares in relation to voting or distribution rights, they generally need to first be offered to existing shareholders on terms that would allow them to maintain their existing rights.

However, a company’s constitution can negate, limit or modify these statutory pre-emptive rights.

An existing Shareholders Agreement may also contain its own rules around new share issues, pre-emptive rights, investor consent or shareholder approvals.

There may also be additional requirements where issuing the new shares affects rights attached to an existing class of shares.

So, before promising an investor a particular percentage of the company, it is important to check what rights the existing shareholders already have and whether those rights need to be dealt with first.

What Other Steps Are Involved In Issuing The Shares?

Once the investment terms have been agreed, the share issue still needs to be properly completed.

Depending on the company and the investment, this can involve board resolutions, shareholder approvals, dealing with pre-emptive rights and checking whether the company’s constitution needs to be amended.

Directors approving the investment also need to comply with their duties under the Companies Act 1993, including acting in good faith and in what they believe to be the best interests of the company, exercising powers for a proper purpose and complying with the Act and the company’s constitution.

Once the shares are issued, the company’s records also need to reflect what has happened.

Under the Companies Act, a share is issued when the holder’s name is entered on the share register. The company must then notify the Companies Office of the share issue within 10 working days and keep its own share register up to date.

Receiving the money, approving the investment, issuing the shares and updating the company records should therefore work together as part of the same transaction.

Do New Zealand Fundraising Rules Matter?

They can.

Issuing shares is not only governed by the Companies Act 1993. Businesses raising capital also need to consider the Financial Markets Conduct Act 2013.

Offers of financial products can require disclosure to investors unless an exclusion applies. Where an offer is a regulated offer, broader disclosure requirements can apply.

Schedule 1 of the Financial Markets Conduct Act contains a number of exclusions for particular investors and types of offers.

One example is the small offers of exclusion. Certain personal offers of equity or debt securities can be made without the usual Part 3 disclosure where the relevant limits are not exceeded - broadly, no more than 20 investors and no more than $2 million raised during a 12-month period.

However, this is not simply a blanket exemption for any raise below $2 million. The offer also needs to meet the requirements of a “personal offer” under the legislation.

Businesses relying on the small offers exclusion also have a notification obligation to the Financial Markets Authority after the relevant accounting period.

So, before taking investment, it is important to check both the company-law requirements for issuing the shares and the financial-markets rules that apply to the way the investment is being offered.

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

Not every investment involves issuing shares immediately.

Early-stage businesses sometimes use an investment structure where an investor provides money now and receives shares later.

Depending on the raise, this might involve an Advanced Subscription Agreement, SAFE or Convertible Note.

These arrangements do not all work in the same way.

An Advanced Subscription Agreement involves an investor providing subscription funds before the relevant shares are issued, with the agreement setting out the circumstances in which the investor will receive shares.

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, on the other hand, generally begins as debt and can later convert into equity in accordance with its terms.

Using one of these structures may mean the investor does not become a shareholder immediately. However, it does not mean the investment can remain undocumented.

The agreement should make clear how much is being invested, when shares may be issued, how the number or price of those shares will be determined and what happens if an expected funding round or other 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, a Share Subscription Agreement can make completion conditional on certain steps happening first.

Depending on the deal, those conditions could include obtaining the required board or shareholder approvals, dealing with existing pre-emptive rights, adopting or amending a company constitution or finalising and signing the Shareholders Agreement.

This can give both the company and investor greater certainty about the proposed deal while making sure the important legal steps are dealt with before the investment completes.

If the Shareholders Agreement is nearly finalised, making its execution a condition of completion can sometimes be much cleaner than accepting the funds 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 you have a term sheet, but the Share Subscription Agreement was never signed. Or perhaps everyone assumed the Shareholders Agreement could simply be dealt with later.

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

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

Remember that receiving the investor’s money does not, by itself, mean the shares have been issued. Under the Companies Act 1993, the share is issued when the investor’s name is entered on the share register.

The company should then check its constitution, any existing Shareholders Agreement, applicable pre-emptive rights, board approvals and company records.

If shares have already been issued, it should also check that its share register and Companies Office 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 progress 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 investor joins the company.

Who gets to make major decisions? Does the investor get a board seat? Are there decisions that require particular shareholder approval? What happens during another funding round? Can a founder sell their shares? What happens if the company itself is sold?

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

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

If there is already a Shareholders Agreement in place, the incoming investor may need to formally agree to be bound by it. This can sometimes be done through a Deed of Adherence rather than having everyone sign an entirely new agreement.

The company should also consider how its Shareholders Agreement works with its constitution. New Zealand companies do not have to adopt a constitution, but where one exists it can modify some of the default rules under the Companies Act and contain important provisions around shares and shareholder rights.

This is another reason it can be much cleaner to deal with the ongoing shareholder arrangements as part of the investment process rather than assuming they can always be sorted out later.

So, Can You Accept 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 investment may need to be documented through a Share Subscription Agreement or similar agreement, alongside the required board process, existing shareholder rights, Financial Markets Conduct Act requirements and Companies Office records.

If the investor is providing money now for equity later, an Advanced Subscription Agreement, SAFE or Convertible Note may be relevant depending on the deal.

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

What you generally want to avoid is taking 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 ongoing relationship between shareholders once the investor is on board.

Where an investor is providing money now for shares that will be issued later, an Advanced Subscription Agreement, SAFE or Convertible Note may be more appropriate.

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

If you would like a consultation on getting the right legal agreements sorted before accepting investments, you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.