Contracts to be signed with investors are extremely important in the partnership process. Getting professional legal support in investment processes is very important. Otherwise, you might easily lose all your shares when you think that everything goes quite well. In this article, you will have the opportunity to see how the investment processes are carried out.

First Stage: Verbal Meetings
The initial contact between the investor and the shareholders is performed through preliminary meetings with a merger and acquisition consultancy company acting on behalf of one of the parties. At this stage, the founders should particularly pay attention to not making too many binding statements and commitments at this stage, and leaving them to the next stage, the Term Sheet stage.

Before an investor takes the business into the Due Diligence process, the shareholders need to make an analysis beforehand for anticipating possible problems and generating solutions to them.

At this stage, a Non Disclosure Agreement (NDA) can be signed with the investor.

Second Stage: Term Sheet (Letter of Intent) and Valuation
After the first contact between the investor and the shareholders, a letter of intent is signed between the parties to establish the framework of the investment. Although it is called a "Letter of Intent" or a "Term Sheet", this document is essentially a preliminary agreement between the parties, and it usually establishes the main points of the "Articles of Association" that will be signed between the parties later. This issue is extremely important and it is recommended that this document should be prepared meticulously and under the supervision of lawyers to prevent loss of rights or misunderstandings later on.

Although the value and terms of the final agreement are determined at the end of the third stage, the Due Diligence Stage, the initial figures of the company valuation can be usually be discussed during the preliminary agreement stage. Valuation means the company value based on which the investor will invest in the company and become a partner. In this context, although the financial indicators are the main issues to be considered for valuation, various factors such as the characteristics of entrepreneurs or key employees of the company can also be considered.

In these meetings, two types of valuation will be discussed: the first is pre-money which means before getting the investment, and the second is post-money which means after getting the investment. To give an example;

Assume that the agreed value of company X is $10,000,000 based on brand value, tangible and intangible assets, and investor Y injects $2,000,000 into the company, in this case, Y will own 16.67% of the company according to the post-money figure. Therefore, current shareholders of the company experience 16.67% share dilution since they have not participated in the capital increase.

Third Stage: Due Diligence
In the due diligence studies, which is abbreviated as the DD process in practice, legal, tax, finance, commercial teams, as well as a special team (IT, etc.) to be established according to the activities of the company to be invested, assigned by the investor address questions related to their fields to the company and request documents related to their answers. Companies can allocate a room to the investor within the company to present the documents, or they can scan the documents and send them electronically. The room where the documents are collected and presented for review is called the 'data room'. If the documents are presented in an encrypted virtual area, it is called the 'virtual data room'. Usually, this study is carried out retrospectively for 3-5 years, and it is ended after two, three, or more rounds of questions and answers; then, the teams submit their reports to the investor.

These studies are very important as the investor will decide on the investment by evaluating these studies. Therefore, demanded answers and documents should be prepared meticulously, which is a very important sign for the continuation of the investment process. Although the cost of DD studies is usually covered by the investor, in some cases, this may be covered by the company to be invested; therefore, it is very important to specify who will cover the costs in the Term Sheet.

Preparing all the details in the DD Check List, which is received from the Buyer at the beginning of the DD, meticulously in accordance with the system in the relevant document is very important for completing the DD stage in a short time and making the Buyer have a good first impression on the company.

Fourth Stage: Agreements
Share Purchase Agreement (SPA)

If the agreement between the parties is based on the acquisition of some of the shares of the company by the investor, then a SPA is prepared between the investor and the current shareholders.

Although the content of the SPA is generally prepared by the lawyers of investors, in some cases, it can also be prepared by the lawyers representing both parties. In any case, the content of the agreement is based on the above-mentioned DD reports. The issues identified in these reports are specified in the Conditions Precedent (CP) document to be corrected before a specified date. That the responsibility will belong to company founders in case of a problem due to these issues is stated in the Representations and Warranties (R&W) document. For example, as a common practice, the founders become solely responsible for the tax transactions before the investment for a period of 3-5 years from the date of signing the final agreement, which is called the Closure Date. Besides, information about the brand, domain name, real estate, vehicles, insurance policies of the company, as well as the employees of the company, are presented in various annexes to the agreement.

As can be seen, DD, which is the previous stage, takes the X-ray of the company. Further studies are carried out based on DD in the next stages.

Shareholders Agreement (SHA)
Regardless of the type of investment, an SHA is signed between the investor and all or some of the current shareholders if they will remain in the company. This agreement arranges the relationship between shareholders and investors after the investment. The most important matters addressed in this agreement are as follows:

Share groups |  Status of the preference shares,

Structure of Executive Board | Number of the members of the Board, number of members appointed by parties,

Board of Directors | Decision quorum in the meetings,

Minority Rights |  This issue is very important for the party that will have the minority rights of the company after the investment. It regulates the works that cannot be carried out without the approval of this minority party. In this context, capital increases, debt over a certain value, asset sales, etc. are included.

Dilution | It means a decrease in shares of shareholders in the company. Dilution may occur as a result of share sale and non-participation in the capital increase. This situation may usually pose a serious problem for the economically weaker party. The share of this group may decrease excessively as a result of a significant increase in the capital of the company. Facebook can be given as a popular example of this. Some shareholders who were involved in the initial phase of Facebook were unable to contribute to the following capital increases; therefore, their shares in the company significantly decreased. Likewise, the investor can request an Anti-Dilution article to protect himself from the economic power of future investors. Generally, their rights are protected by the clauses of the minority rights.

Non-Competition | Usually, when an investor invests in the company, they ask the entrepreneurs of the company not to do another business to compete with the company. The scope of the non-competition article may specify that the entrepreneur shall spend (X)% of his/her time on the business of the company.

Limitation of share transfer | This is the most sensitive issue in SHAs. Usually, the following limitations are specified:

  • Preemptive Right: If a company issues new shares, the current shareholder will have the first option to acquire these shares.
  • Right of First Refusal (ROFR): A shareholder is obliged to offer his/her shares to the other shareholders on the same terms before selling the shares to someone else. These shares can be sold to third parties only if other shareholders do not want to buy them.
  • Drag-Along/Tag-Along Right: Drag-Along means if one of the shareholders wants to sell his/her share, he/she can force other shareholders to sell their shares as well. For example, if an investor wants to acquire the whole company, this right allows selling the company as a block. This article is usually in favor of the investor or the majority of the shareholders, and it is requested by the investor.

    On the other hand, Tag-Along means the right of other shareholders to be included in the sales if a shareholder wants to sell his/her shares. For example, if the investor wants to sell his/her shares, other shareholders will also have the option of selling their shares and exiting. This article is generally in favor of small shareholders.

  • Call Option / Put Option: Put Option refers to the right of one or a group of shareholders to sell their shares to other shareholders or group of shareholders under certain conditions (price, etc.) and/or within a certain period of time. On the other hand, Call Option refers to the vice versa, i.e. the right of shareholders or group of shareholders to buy other shareholders' shares. In this context, the buyers do not have the right to waiver from the Put Option right while the sellers do not have the right to waiver from the Call Option right.

    Subscription and Shareholders Agreement (SSHA) to enter the company through a capital increase rather than buying shares. In this case, a SPA is not signed, instead, the conditions for the investor's entry to the company are regulated with a single document that includes the CP and R&W parts and the SHA. The capital is increased by a general meeting to be held by the company. This capital is committed only by the investor, and as a result, the investor enters the company with the capital he/she pays. The only difference of this method is the way the investor enters the company. Other parts of this method are carried out in line with the abovementioned methods.

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