With more ideas brewing in college labs and more private/public incubators being set up, many of the common venture funding terms are not captured when investors and entrepreneurs transact in Kuwait. In a country where approximately $750mn of government funding is allocated to start-up related projects, the bylaws of a company is the only legal binding document that highlights the relationship between investors and the entrepreneurs, and is very standardized with no room for any preferred treatments. As a result, the transaction process for early stage funding in Kuwait is also very primitive relative to the rest of the region and the international scene; this is the main reason why modern local entrepreneurs and investors prefer transacting outside of Kuwait.
The following are a few thoughts that may be useful to take into consideration for future funding rounds.
Typically in early stage funding, a term-sheet is an agreement that is entered between financiers and entrepreneurs which outlines the key financial and non-financial terms of a proposed investment. In developed venture communities, financiers and entrepreneurs have established a more common template for funding rounds. With the exception of exclusivity and confidentiality, provisions of a term sheet are usually not legally binding however should highlight certain milestones or conditions that are precedent to investment which both parties agree to meet. Despite provisioning not being legally binding, terms may be rectified based on new findings that have direct impact on the transaction and is typically used in the negotiation rounds before reaching a final agreement. Once due-diligence is performed (legal, commercial, technical, or financial depending on the level company’s maturity level), the revised terms are usually captured in a shares purchase agreement (SPA) and shareholders agreement (SHA), with the amended articles of association (AoA) reflecting the new legal changes.
The shares purchase agreement contains details of the funding round including the number shares subscribed, share class, and payment terms with representations and warranties about the condition of the Company. These representations and warranties are qualified by a disclosure letter that specifically highlights all necessary factual information prior to the completion of the transaction. The second agreement is called “shareholders’ agreement” and will usually contain investor protection rights, including consent rights, control measures, governing policies, board representation and non-compete restrictions. The “articles of association” contract would include the company activities and engagement rights, the rights attached to the various share classes, the procedures for shares’ issuance and transfer, annual shareholders and board meetings’ procedures. Commonly highlighted terms in early stage funding term sheet include:
Share classes, valuation and milestones attached, dividend rights, liquidation preference, shares redemption, conversion rights, automatic conversion of shares/series, anti-dilution, founders’ shares, pre-emptive rights on new shares issuance, first right of refusal, tag-along, drag-along, representations and warranties, voting rights, consent rights, board/governance, information rights, exit, registration, management non-compete agreements, intellectual property assignment, employee stock option plan, transaction/monitoring fees, exclusivity, enforceability and conditions precedent.
Depending on the nature of the transaction and market conditions, term sheets are tailored to meet the specific needs of the transaction as appropriate. They are also very dependent on the maturity of the overall venture ecosystem and are fine-tuned to match the transaction needs in accordance with the domestic legal framework.
A funding round is usually led and managed by one venture capital firm or angel network that would put together a syndicate either before or after the term sheet is agreed on. The syndicate will usually comprise some or all of the existing investors and new strategic ones that demonstrate arms length value add capital. Once agreed by both parties (new financiers and existing shareholders inclusive of management), the term sheet is used by lawyers as a basis for drafting the investment documents; the more detailed the term sheet, the fewer issues you will have in the final stages of the drafting process. The process can be complex, therefore working with lawyers familiar with venture capital transactions is highly recommended to reduce the margin of error/ambiguity, the time frame and associated costs.
Despite the complexity of how the transaction process may seem, the actual process and its time horizon is quite simple and short. In early stage funding, the transaction process would typically take no more than 60 days depending on the level of the company’s maturity and the complexity of the product/services. More importantly, early stage funding is a very intimate process that is centred around the working culture and the execution capability of the management team; a smart and hard working team is the main factor for a successful funding round.
Wishing you all a Happy New Year and hope to see you in the next StartupQ8 event (21/1/2013) !
Abdulaziz B. Al Loughani