Whether you need to overcome financial obstacles, create expansion opportunities, or want added expertise, the right investor(s) can fulfill your need—provided you have an agreement outlining what those needs are and, in return, the compensation investors can expect. Learn how to write an investor agreement and help secure the funds you need to move forward confidently, then speak with a legal professional to execute the contract accordingly.
Investor agreement: what it is and why you need one
Investment agreements are legal contracts between an investor and a company. The investor supplies funds with the intent of receiving a return. In turn, the company protects the individual's financial investment in the business. The Securities Act of 1933 governs investment contracts.
According to the U.S. Securities and Exchange Commission (SEC), an investment contract is only valid if it meets the following criteria laid out by the Howey test:
- It is an investment of money.
- There is an expectation of profits.
- The acquisition is in a common venture.
- Any profit comes from the efforts of others.
A well-executed agreement can help secure the investor's interests and safeguard your company. According to Global Negotiator, "the purpose is twofold": It will ensure you meet your financial undertakings while protecting investor funds without jeopardizing your enterprise. The SEC provides a sample investment agreement, giving you an idea of what it looks like.
[Read more: Business Investors: A Guide to Knowing When and How to Find One]
Types of investors
An investor can be a person or a business entity. For example, a family member could contribute some of their savings to your company in exchange for shares, or a corporation could invest funds in a joint venture where the corporation itself is the investor.
Five common investor types include:
- Personal investors, like friends and family.
- Peer-to-peer lenders, such as group lending or crowd-sourcing.
- Banks, which act as a source of capital for established companies.
- Angel investors, who invest in startups or new entrepreneurs.
- Venture capitalists, including well-off investors and investment banks.
Enterprises typically use investor funds to launch a new business, scale operations, upgrade equipment, or hire new staff. However, each circumstance varies, so UpCounsel suggests seeking legal guidance before reaching out to investors.
A well-executed agreement can help secure the investor's interests and safeguard your company.
Investor agreement formats
Although the basic information required in investment agreements is the same, the structure differs according to the type of investment. Your financial and legal advisors can help you select the correct format.
The Finity Law Firm lists the most common types of investor agreements as follows:
- Stock purchase agreement.
- Stock option contract.
- Restricted stock agreement.
- Royalty, commission, or percent of revenue.
- Convertible debt agreement.
- Deferred compensation.
[Read more: 3 Investors Demystify Why Some Startups Win Funding Windfalls]
What to include in an investor agreement
A well-executed agreement should include the basics, such as names and addresses, the amount and purpose of the investment, and each party's signatures. In addition, when drafting an investor agreement, the Kumar Law Firm said to be concise and not leave room for ambiguity. "The terms of the investment should be clearly laid out in the agreement," the firm advised.
Although each investment agreement differs, most should include the following:
- Fundamental terms: Describe the amount and transfer date of the investment and note the tender, such as cash, certified check, or tangible assets. Also, record the allotments of funding, a timeline of when the contract commences and expires, and if the investor gets voting rights.
- Terms of the return on investment (ROI): Determine if and when the investor will receive an ROI. Stipulate what kind of ROI, namely a lump sum payment with the return on their investment, an agreed-upon interest rate paid annually, or a figure based on the project's profitability.
- Other details: Include any restrictions regarding the investor's rights, a strategy for solving disputes, and consequences for violating the contract. Additionally, the Kumar Law Firm recommended addressing what happens to the funds if the company is dissolved or files for bankruptcy.
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