Faster And More Cost-Effective: Unpacking the BVCA's Model Document Updates
The British Venture Capital Association (BVCA), the representative body for the UK's private equity and venture capital industry, recently updated its standardised model legal documents for venture capital transactions in the UK. The aim of these updates is to streamline and expedite the investment process, aligning with current investment practices while also reflecting the growing significance of US investors and the increasing complexity and range of investor profiles.
The recent changes to the model BVCA documents reflect a significant and welcomed shift in the UK's venture capital landscape. The revised model documents have the potential to simplify the early-stage investment process and provide more flexibility in deal structuring. Ultimately, this means reducing the cost of negotiating a fundraise and limiting discussions amongst stakeholders and their counsel about what is expected on a funding round.
While many contentious negotiation points have been removed, we also anticipate that parties may resist or negotiate certain changes introduced by the BVCA, particularly those that give prominence to 'major investors' – a concept more common in the US venture capital market. We have seen a seismic shift in US investors entering the UK market and therefore, aligning deal terms is a helpful process to facilitate positive change and make US investors feel more at home. As always, a pragmatic balance must be struck between the interests of investors, the capabilities of the investee company, and the flexibility necessary for its growth.
The purpose of this article is to delve into the recent changes introduced by the BVCA and explore their significance for investors and founders.
Structural and mechanical changes
1. Structure - The consolidated Subscription and Shareholders Agreement has been replaced by a standalone subscription agreement containing only the investment-specific provisions and a separate shareholders agreement. This allows for the continuing relationship among shareholders to exist separately in the standalone shareholders' agreement, given it is intended to be a living document to which new investors can adhere. This approach enables companies to streamline amendments in connection with their financing rounds.
2. Completion mechanics - Complementing the structural changes, BVCA has now introduced the concept of "lead investor" into the documentation, intended to simplify decision-making. It has also clarified when completion takes place: there is now a short payment window after executing the Subscription Agreement, alongside provisions to exclude any investor who fails to pay within that timeframe. If the specified investment threshold is not met within the designated timeframe, the investee company (with consent from the lead investor) can terminate the Subscription Agreement.
Governance and conduct
3. Investor consents - The new model documents aim to enhance clarity in the decision-making process and establish clear guidelines for when investor consents are required – the schedule of reserved matters has therefore been tidied up and made clearer. Investor director consent has also been retained at board level in respect of the day-to-day matters, however investor directors no longer have authority to approve matters reserved for investor approval. Relatedly, the BVCA also introduced the concept of "Major investors", who can decide on pre-emption rights in connection with a financing round (further explained below, in paragraph 7).
4. Company board - Company boards have been given increased authority over specific matters such as share transfers and exits, and restrictions on disclosing information to potential purchasers without consent, giving the company greater flexibility and oversight over its cap table.
5. Founder's rights - The updated model documents expressly allow founders to appoint themselves as directors while they are employed by or provide consultancy services to the company; however, this right falls away once they cease to be engaged by the company. Notably, the general restriction on founders transferring shares without Investor Majority Consent has been eliminated, though other safeguards remain in place to ensure founders' continued involvement and commitment to the company.
6. Conduct of business - The new model shareholders' agreement introduces various undertakings to enhance corporate governance standards and regulatory compliance, aligning with the expectations of institutional investors and private capital firms. These undertakings include adopting a code of conduct for workplace behaviour, implementing diversity and anti-harassment policies, conducting a data protection compliance audit, and addressing ESG-related considerations such as climate and diversity and inclusion policies. Additionally, the company would prepare a technology-focused sustainability impact plan in collaboration with investors. A pragmatic approach is necessary to ensure the undertakings align with the company's capabilities and resources.
Bringing in new shareholders
7. Pre-emption rights - To complete any new financing round, by law UK companies must ensure 75% of voting shareholders agree to waive their statutory pre-emption rights. Minority shareholders may insist on subscribing for the new shares on a pro-rata basis, making it difficult or time-consuming to bring in a new investor, without certainty of delivering the full allotment to the new investor. Thus, the new model documents limit pre-emption rights to investors or major investors only. They also enable the "Investor Majority Consent" to disapply or waive pre-emption rights, subject to appropriate safeguards that would re-engage pre-emption rights where they go on to participate in the financing following a waiver. Effectively, the changes provide more flexibility for the company and its significant investors to guide the financing decisions of the company.
8. Consent rights - Amendments to the articles of association are often required throughout the company's life cycle, from seed funding to pre-IPO. By law, amendments to the company's articles require the approval of 75% of voting shareholders, plus additional consent of 75% of each class of voting shareholders whose rights are affected by the proposed changes. Effectively, this threshold allows a minority of just over 25% of all equity shares, or 25% of any class of shares, to impede changes required to facilitate an investment. The updated model documents seek to address this risk by lowering the consent threshold to a majority of the relevant class of shares affected by the proposed change. Corresponding provisions have also been included in the shareholders' agreement, allowing it to be updated and restated in future funding rounds without the consent of all parties.
9. Drag-along - Previously, dragged shareholders were not required to contribute to sell-side liabilities in respect of any representations, warranties, undertakings and/or indemnities given by any of the consenting sellers. To ensure a fair distribution of costs associated with a sale, the updated articles require all dragged shareholders to proportionately contribute to sell-side obligations (whether by means of escrow, holdback, or reduction of consideration), with their liability capped at the purchase price received.
10. IPO & HOLDCO - To facilitate reorganisation and pre-IPO activities where the shareholding structure remains materially the same, the revised model documents now include provisions allowing the establishment of a new holding company (interposed between the company and its shareholders) without unanimous shareholder consent. The model documents also introduce lock-up provisions during IPOs, restricting share transfers for up to 180 days. Reflecting market practice, Investors are no longer exempt from providing warranties or indemnities on a Sale or IPO.
Economic rights and investor protections
11. Liquidation preference - The updated model articles modify the liquidation preference for preference shares, which grants investors the option to receive the greater amount between their liquidation preference amount and the distribution available to ordinary shareholders (as if the preference shares had converted into ordinary shares). This change reflects the market practice, eliminating the administrative burden of converting preferred shares before returning capital. On a related note, the definition of "Arrears" has been narrowed to include only declared and accrued (but unpaid) dividends, to the exclusion of interest and "other amounts payable" from the Preference Amount investors are eligible to receive.
12. Anti-dilution - Reflecting market practice, the updated articles of association provide for the broad-based weighted average as the default anti-dilution ratchet formula. The "weighted average" formula now considers each share class's relative proportions and weighted average equivalent prices instead of the lowest price per share. This ensures that the dilution of existing shareholders is accurately reflected, considering the varying values ascribed to any new securities. The alternative full ratchet and narrow-based weighted average ratchet formulas are retained as drafting options.
13. Warranty protection - Founder warranties, a key area for investors' protection, have been removed, so liability associated with a breach of warranty now falls solely on the company. Investors are likely to resist this change, particularly in early-stage investments where it's important to focus the founder's mind on the warranty package. Next, the general disclosure of the data room – a typical feature in UK and European transactions, where broadly everything added to the data room is deemed to qualify the warranties - has been replaced by a detailed disclosure focused on specific information, a process more typical on US deals. This is quite an investor-friendly approach as it limits investors' review to only relevant and specific documents. In contrast, general disclosure of the data room was previously a given and if investors chose not to review all of the data room that risk was theirs to calculate. Additionally, a more comprehensive set of warranties is now included in the Subscription Agreement.
14. Leaver provisions - The leaver provisions, governing what happens with the shares of an employee or consultant when ceasing to be engaged by the company, have undergone significant changes. The definition of "Bad Leaver" has been tightened to focus on events truly detrimental to the company, such as gross misconduct, resignation within a specific period, or material breach of non-compete obligations. Conversely, bad leavers will automatically forfeit all their shares rather than - as was previously the case based on a vesting schedule. Correspondingly, "Good Leavers" would only retain the vested portion of their shares (subject to an optional one-year cliff period) instead of being entitled to keep all of their shares under the previous approach.
Other notable changes
15. Co-sale rights - The co-sale rights in respect of shares proposed to be sold by an employee or consultant have been revised to extend only to Major Investors instead of all holders of equity shares or preferred shares.
16. Information rights - To reduce the disclosure burden on the investee company, the updated Shareholders' Agreement provides a drafting option for only "Major Investors" to receive information rights concerning the company, rather than all investors.
17. Liability limitation - The limitation period for all warranty claims has been reduced to 18 months instead of 2 years, which aligns with market practice. Along with removing the de minimis (i.e., minimum threshold before a warranty claim can be brought) and aggregate claims thresholds, these changes are intended to simplify and expedite the resolution of warranty claims.
18. Legal costs - The updated Subscription Agreement provides that the company would only cover the costs and expenses of the Lead Investor rather than those of all investors up to a capped amount. It’s likely that investors will continue to expect that the company will meet some or all of their costs.
19. EIS & VCT - The model documents now include EIS and VCT provisions designed to streamline EIS/VCT analysis for investors, reflecting the increasing significance of these types of investors and bringing a degree of standardisation to this area. Alternative distribution waterfalls are also available for EIS/VCT investors.