How to Protect Yourself from Liability for Reps in an Investment Agreement? (3)

You founded a startup to bring it to business prosperity and an exit. To achieve your target, you will probably have to obtain financing from investors. If you are not careful with the representations in the investment agreement, you are risking the success of your startup and yourself personally. It sounds frightening, but it is possible to mitigate the risks in the framework of the investment agreement.

What are the representations?

In each investment agreement, there are representations by the company that sprawl on many pages. The reps constitute approximately one third of the agreement.

The representations are meant to provide the investor with a picture of the company’s condition at the time of the investment. The level of detail of the representations depends on the type of investor, the compamny’s stage  etc. The representations refer to a variety of subjects, such as obtaining the resolutions required for the transaction, the company’s intellectual property, its financial condition, the company’s contracts, its employees and legal proceedings in which it is involved.

The rep provisions usually deter investors, founders and officers. However, such reps constitute a sort of insurance of the investor for a rainy day: if it found that the reps were incorrect, the company shall be exposed to a claim by the investor for his damages. Due to the nature of the reps, the founders and officers’ knowledge is essential for their examination. Therefore, the reps are a most important part of the investment agreement and the founders, officers and investors have to be involved with respect thereto.

What should you insist on?

So, what should the company insist on?

  1. Reducing the scope of representations and subjects covered thereby. For example, qualifying to the company’s knowledgethe rep with respect to non-infringement of third party rights by the company intellectual property .
  1. Full and accurate disclosure of all information required pursuant to the reps. Certain founders tend to conceal information that may expose negative aspects of the company. However, such concealment exposes the company to a future suit, while disclosure shall usually not terminate the transaction. Of course, when the information is sensitive, the disclosure should be made in an intelligent manner so that the company and the deal are not harmed.
  1. Avoiding “future looking” reps, such as references to the company’s prospects. The purpose of the reps is to provide the investor with a picture of the company’s conditions at the time of the investment.
  1. Limitation of the company’s liability to the investment amount and to a period (usually between one year and the status of limitations, per the rep’s type).
  1. Consult not only your lawyer, but also the other professionals, such as accountants and tax advisors, available to you. It is important that you and the various professionals are coordinated. Therefore, I recommend at least one meeting between you and all professionals relevant to the reps.

 

The investor, who shall prefer, of course, as little limitations on the reps as possible. For the investor, it is important to ensure the limitations do not apply to cases of fraud.

The younger the company is, the stronger is the demand that the founders are personally liable for the company’s reps. This puts at actual risk the founders themselves and their personal assets. I advoce the foudners to make sure that their liability is limited, in addition to the aforesaid limitations, in further customary ways, such as limiting the investor’s remedies to the founders shares in the company.

 

What dilemmas did you stumble into with respect to representations in investment transactions? How did you resolve them?

 

Hebrew version – http://www.news1.co.il/Archive/003-D-126402-00.html