The British Private Equity & Venture Capital Association (BVCA), the industry body for UK private equity and venture capital, has published updated model documents for early-stage capital investments, with the aim of promoting industry-standard legal documentation in the UK.
The BVCA model documents have, traditionally been widely adopted across the market as a starting point and, as they are not drafted in favour of any party, are considered to be a useful benchmark for both investors and entrepreneurs on what could be considered a 'market' position – although the 'market' position at any given time may of course be quite different to these updated model documents.
In February 2023, revised and updated model documents were published following a review by the BVCA's legal and accounting committee as well as a working group with members (from both the investor and legal communities).
This note sets out the key changes contained in the updated model documents.
Why are these changes needed?
The need for a remodel is unsurprising, given the time elapsed since the last set of documents were produced as well as the pace at which the private equity and venture capital market develops in the UK and abroad.
In its recent webinar, a panel of those involved in updating the model documents explained that there are a number of trends driving the latest amendments. One trend is the continued significant influence of US capital in the UK market. As the volume of US capital in the UK continues to grow, UK investment documentation is increasingly aligned with US standard documentation (and practice) and in particular, the provisions contained in the US National Venture Capital Association (NVCA) model legal documents for venture capital financings.
This makes sense: as UK companies continue to attract US investors, the investment documentation should meet the needs and expectations of those investors, and providing standardised terms should help to create a more efficient process.
Other amendments ensure that the model documents "catch up" with developments in market practice and reflect terms already commonly seen in investment documentation.
Model Subscription Agreement
The BVCA has split the combined Subscription and Shareholders' Agreement into a model Subscription Agreement and a separate model Shareholders' Agreement (discussed later this in this note).
There are clear benefits to this approach. It should enable the company to undertake future funding rounds more efficiently without necessarily revisiting the key terms contained in the Shareholders' Agreement and Articles of Association.
In future financing transactions, investors simply enter into a short new Subscription Agreement with the company, but the key terms setting out in the investors' rights will be contained in the company's Articles of Association and Shareholders' Agreement, to which the new investor will adhere (and, to this end, the adherence provisions have been updated).
Clearer completion mechanics: the completion mechanics have been updated to provide that any conditions to completion are assumed to have already been fulfilled on the date that the parties enter into the Subscription Agreement.
There is then a short window of time immediately following execution of the Subscription Agreement for the investments to be made. Provisions are also included in relation to any investor that defaults and fails to pay their subscription proceeds within the specified timeframe. These will allow for any defaulting investor to be excluded from the Subscription Agreement and enable the company (together with the consent of either the Lead Investor or a Subscriber Majority) to terminate the Subscription Agreement in the event that a specified threshold in relation to the investment round is not met by a certain date.
The updated Subscription Agreement is now drafted on the assumption that the investment will be made by investors in a single tranche (which reflects typical market practice) but there is optional drafting in the appendix to the Subscription Agreement if the investment is to be made in multiple tranches.
Introduction of provisions for convertible equity at time of funding: it is common for any convertible notes or SAFE notes issued by the company to convert at the same time as a series A investment is made. The updated Subscription Agreement includes standardised drafting to allow for this conversion into equity as part of the completion mechanics.
The founders no longer provide commercial warranties: previously the founders and the company would provide commercial warranties to the investors, which meant that – up to an agreed level (usually a multiple of salary) – founders were liable for warranty breaches. The updated Subscription Agreement provides that only the company will provide warranties.
While that is the case, any warranties qualified by the "awareness of the company" will be deemed to include the actual knowledge of each founder and executive directors of the company.
The model documentation is designed to be used by more established companies seeking series A funding (in contrast to, for example, seed investment) where the expectation may remain that founders will continue to have 'skin in the game' (in the form of potential warranty exposure) but this is a clear demarcation from the previous position. This is certainly an area where the dial has been moved firmly in favour of founders and so it will be interesting to see whether the market adopts this approach, or whether we will continue to see founders providing commercial warranties (particularly as the funding market tightens).
Removal of the de-minimis threshold and basket amount for a warranty claim: the de minimis threshold and basket amount (below which a warranty claim may not be made) has been deleted. The BVCA has confirmed in its webinar that this is to simplify the limitation schedule and avoid the requirement for unnecessary negotiations around an appropriate de minimis amount.
Updated warranties: as a general point, the BVCA has confirmed that the warranties have been drafted on the assumption that they will "generate a detailed disclosure process to fully inform the investors and there will be no general disclosure of any data room or due diligence documents under the disclosure letter." To this end, a form of disclosure letter has been provided as an appendix to the Subscription Agreement which provides that only those documents specifically referred to in the specific disclosures should be included in the disclosure bundle. We suspect this will be well received by investors and should help make the disclosure process more efficient, by reducing the number of documents to be reviewed as part of any disclosure process to solely those relevant, and specific, documents. A balance may, however, need to be struck where this change would create an excessive disclosure burden for the investee company.
Certain warranties have been significantly updated including those in relation to intellectual property, data protection, sanctions and the UK National Security and Investment Act 2021. Also, with environmental, social and governance (ESG) being at the top of many investors' considerations, new warranties have also been included including in relation to the ESG policies of the company. The new ESG warranties should ensure that those investing in companies have a clear understanding of the extent to which ESG is embedded within the company and, along with the undertakings in the Shareholders' Agreement, can seek to ensure that the investment remains aligned with their own ESG requirements.
Finally, new optional US tax warranties have been included which can be included if any of the investors are subject to US taxation (and new optional US tax covenants have also been included in the model Shareholders' Agreement).
Only the legal costs of the Lead Investor to be reimbursed by the company: the updated Subscription Agreement provides a drafting option for only the costs and expenses of the Lead Investor (instead of all investors) to be met by the company.
This is a shift from general market practice to date, and it will be interesting to see whether other investors will continue to expect that some or all of their costs will be met by the company, notwithstanding the updated default position contained in the Subscription Agreement.
Model Shareholders' Agreement
Information rights: the updated Shareholders' Agreement provides a drafting option for only 'Major Investors' (those investors holding a specified equity interest in the company) to receive information rights in relation to the company, rather than all of the investors. This option ensures that the burden on the investee company is manageable and is aligned with US (and more enlightened existing UK) practice on this matter.
Undertakings: new undertakings have been included in the Shareholders' Agreement including that the company will adopt a number of ESG policies including a climate policy and a diversity and inclusion policy, in each case as approved by the Investor Majority. The company will also, in collaboration with the investors, prepare and maintain a sustainability impact plan in relation to the company's technology.
Removal of the ability for an Investor Director to approve Investor consent matters: the updated Shareholders' Agreement has removed the ability for an Investor to nominate its own Investor Director (or another person) to approve those matters subject to the prior consent of the Investor. This may result in a more complex, and time consuming, consent process for companies to follow in relation to Investor consent matters.
Updated amendment and restatement provisions – the updated Shareholders' Agreement now contains standardised amendment and restatement provisions to allow for the Shareholders' Agreement to be updated and restated in future funding rounds with the consent of certain shareholders (rather than all parties to the Shareholders' Agreement). This is a welcome update (consistent with both US and more enlightened existing UK practice) and should allow the Shareholders' Agreement to continue to be used for future funding rounds.
The ability to vary and amend the Shareholders' Agreement, without the consent of all parties, is consistent with the updated provisions in relation to the variation of share class rights (detailed in this note below). In practice, a variation to the Shareholders' Agreement may, in turn, require a variation to the Articles of Association (and vice versa) so it makes sense for these provisions to broadly align.
Model Articles of Association
Liquidation preference: the liquidation preference for the series A shareholders held by investors has been updated to provide that each series A shareholder will automatically receive the greater of the preference amount on each Series A share and the amount that would have been received if the series A shares had been converted into ordinary shares prior to any distribution. The BVCA has confirmed that this reflects general market practice and is a change we welcome, as it avoids the potential need to convert on an exit to obtain the most preferential treatment. The new drafting does not however address certain (more complex) multiple returns situations, for which investors, entrepreneurs and their advisers may wish to consider making provision.
If the investment includes EIS/VCT investors, an alternative EIS/VCT distribution waterfall is provided in the Articles of Association.
Variation of rights attached to share class: where the share capital of the company is divided into different share classes, the special rights attached to any class may only be varied with the consent of a majority of the issued shares of that class. This was previously set at a higher threshold of 75%. Whilst the reduction in the consent threshold for class rights variation will introduce greater flexibility into financing structures, the new model documents do not address some of the other tricky questions that can arise in connection with class rights variations.
Updated anti-dilution provisions – the Articles of Association have been updated to provide that the default anti-dilution ratchet in relation to anti-dilution provisions is a broad-based weighted average ratchet formula. The alternative full ratchet and narrow-based weighted average ratchet formula remain in place as drafting options set out in the appendix to the updated Articles of Association. It feels like an opportunity was missed in these provisions (and corresponding provisions elsewhere in the Articles) to align the approach more closely with that taken by the NVCA documentation.
Disapplication of pre-emption rights: the updated Articles of Association provide that the Investor Majority can disapply the application of pre-emption rights in relation to the issue of new shares or other securities. This previously required a special resolution. The BVCA notes that, as in practice pre-emption rights will need to disapplied in most financings, care should be taken to ensure that the disapplication threshold is not set too high which may effectively provide certain investors with small(er) shareholdings a right to veto future funding rounds.
While that is the case, the updated Articles of Association include a mechanism whereby if the Investor Majority disapplies pre-emption rights but then an investor (forming part of the Investor Majority) goes on to participate in the issue of new shares, each investor can participate in the same allotment of new shares. In its webinar, the BVCA notes that it has sought to create balanced and fair model documents and this "fairness language" is an example of this. This may provide some comfort to smaller investors in a company that the larger funds will not simply dilute -them down in subsequent financings.
The updated Articles of Association also provide that pre-emption rights in relation to the issue of new shares is limited to investors or Major Investors. This is commonly seen in US transactions and the BVCA notes that this should make it easier for a company to raise new finance (as the pre-emptive offer process should be more “manageable” for companies with larger cap tables – for example those that have issued equity as consideration in M&A activity).
Updated leaver provisions: the updated Articles of Association provide that all shares held by a Bad Leaver will convert into worthless deferred shares. A percentage of shares held by a Good Leaver will convert into deferred shares (which decreases over time), with a 12-month cliff on vesting being included as an optional drafting.
The definition of a “Bad Leaver” has been tightened to focus on those events which are truly harmful to the company including events within a founder or employee’s control – for example, dismissal for gross misconduct, their resignation (which can be limited to a specific period of time) or a material breach of any non-compete obligations (whether contained in the Shareholders’ Agreement or otherwise). “Good Leavers”, covering all leaver scenarios which do not count as “Bad Leavers”, will be entitled to retain all of their vested shares, albeit on a disenfranchised basis.
It’s reasonable to expect that the treatment of shares held by leavers will remain a closely negotiated point, notwithstanding the updates made in the new model documents.
Co-sale rights: the co-sale rights have been updated and now only allow an investor or a Major Investor to have co-sale rights in the event that a founder or someone who is employed by, or provides consultancy services to, the company (a Service Provider) sells their shares. The co-sale rights were previously extended to any holder of equity shares or series A shares.
Drag-along rights: the drag-along provisions have been updated to make it clear that the dragging shareholders and the called shareholders will be treated broadly the same in relation to the consideration received by each party. In particular, the consideration received by a called shareholder may be subject to arrangements such as escrow or a requirement to contribute to transaction or insurance costs (more, generally, referred to as Common Liabilities). We suspect that this change will be well received by both investors and founders. In practice, existing well drafted drag provisions (which can be seen as setting the "backstop" terms for a sale) will already make provision for this and for various other matters arising in the context of a sale.
Board appointment rights: these are now contained in the updated Articles of Association, rather than being in both the Shareholders' Agreement and the Articles of Association.
Right of founder to appoint a director if a Service Provider: the updated Articles of Association provide that a founder shall only have the right to appoint themselves as a director of the company if they are a Service Provider. In other words, this right depends on the founder remaining employed by, or providing consultancy services to, the company.
'Holdco flip': the new Articles of Association have been updated to include a new provision allowing for the board (including an Investor Majority) to insert a new holding company, with shares (and rights) being mirrored for shareholders in the new holding company. This will be a useful provision when seeking an IPO and would avoid the need, in the absence of the consent of each shareholder, to go through a scheme of arrangement in the UK to create such a clean holding company. This type of provision is one which we (at Shepherd and Wedderburn) have included for many years in our form of documents and we welcome the update here.
Lock-up provisions: the updated Articles of Association provide for lock-up rights in relation to an IPO (for a period not exceeding 180 days starting from the date of the final offering document relating to an IPO). This would bind all members and so assists where it is not possible, or practical, to have shareholders sign up to lock-up arrangements, but we expect the provision may still require negotiation.
The updated model documents should be generally welcomed by those involved in Series A funding rounds (and beyond).
It is clear that the increase over recent years of US investment in UK companies has had a significant impact on the BVCA model documents, which are now more closely aligned with similar documentation in the US. The new model documents also make provision for typical series A terms to co-exist with those which typically apply to investments seeking EIS or VCT treatment – again something which is increasingly seen in series A financings.
While the updates to the BVCA model documents are welcomed, each transaction will of course have its own requirements and care will need to be taken to ensure that the updated model documents meet the expectations of the parties. We look forward to seeing how market practice develops in this area; in particular the pace at which UK practice continues to align with that in US venture deals. As always, it is critical to obtain input from your trusted corporate advisors when embarking on such a Series A funding round.
Upcoming interactive sessions: Series A and beyond
Join us for an in-person session on 7 or 14 June reviewing both the key changes and takeaways that investors and founders should be aware of and also the key discussion points that are likely to arise in deals papered with the new model forms. This interactive session will be led by one of our corporate partners, Stephen Trombala, who has over 25 years' experience in venture capital and private equity transactions advising both founders and funds on investments and exits. Book your place here.