An agreement drawn between the investors and a startup company that lays down the rights of the investor as a stakeholder of the company is called an investor rights agreement (IRA). The investors might negotiate to have rights of first refusal and other such rights that make the investment a better deal for them.
The startup would be interested in granting the investors these rights in order to obtain a capital investment that they would not have gotten under other circumstances.
When Do You Need an Investor Rights Agreement?
A startup looking to secure investment from venture capitalists or other capital financing institutions might choose to offer them certain rights such as the right of first offer which allows the investors to maintain proportional ownership in the firm if the firm gets itself listed on the stock exchanges and the right to elect a representative to the board of directors, to receive financial reports of the firm from time-to-time.
You would need an investors rights agreement if:
- You are a startup looking to attract investment from venture capitalists and other investors.
- You are an investor investing in a startup and would like to get the best value for your investment.
Inclusions in Investor Rights Agreement
A standard IRA will include the effective date of the agreement, the names, and descriptions of the parties to the contract, registration rights, right to future securities issuance and to that of first offer, information and observer rights, restrictions on these rights and to the transfer of eligible securities by investors.
It must also contain clauses that limit the liabilities of the parties, terms of termination of the contract, the governing law, and any other terms that may be required by state, federal, or international laws and conventions. As with any agreement, caution must be exercised when framing the terms of the contract in order to avoid any unforeseen liabilities that may arise.
The terms must be satisfactory to all parties of the contract and must not be vague, as this could lead to miscommunication and disputes.
How to Draft Investor Rights Agreement
The procedure to draft an investor rights agreement:
- Mention the effective date.
- Identify the parties to the contract and the relationship between them.
- Include registration rights that may be granted to the investors, including clauses that provide for demand registration, company registration, underwriting requirements, the obligations of the company, expenses of registration, indemnification, termination of registration rights, and/or any other provisions that may have been agreed upon.
- Make provisions for information and observer rights, including those for the delivery of financial statements, inspection, and termination of information and observer rights.
- Include rights to future securities issuances including the right of first offer. Also, include a clause that governs the termination of these rights.
- Additional covenants that cover the insurance, employee agreements, employee securities, board matters, accounting, and the termination of these covenants.
- Include standard terms such as warranty, dispute resolution, and any other terms that may be required by law.
Benefits of the Investor Rights Agreement
The benefits of having an IRA include:
- It grants rights to investors that might make the investment in the startup much more attractive to prospective investors, allowing the startup to gain much more capital than it would have been able to obtain otherwise.
- It makes the prospects of investment much more attractive to the investors and ensures that they are getting the best value from their investment in the company.
- Information and observer rights allow the investor to periodically inspect the financial performance of the company so they know what returns they can expect from the company and what future decisions they should take.
Key Terms/Clauses in the Investor Rights Agreement
The following key terms must be included:
- Registration Rights: This clause mentions the rights of the investors to demand registration, the obligations of the company in this regard, and the indemnification of the investors.
- Information and Observer Rights: This clause allows the investors to monitor and gauge the performance of the company that they’ve invested in, so they can plan their present and future investments accordingly. Additionally, it safeguards investors against malicious intent and fraud.
- Termination of Rights: This clause deals with the terms of termination of the rights that are granted by the agreement.
- Limitation of Liability: This limits the liability of the investors and the company and safeguards them from any unexpected liabilities that may arise in the future.
- Dispute Resolution: This clause makes provisions for how disputes arising from the non-performance or default of the terms of the agreement will be dealt with by both contracting parties.
[Also Read: Restated Investors’ Rights Agreement]
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