What are Conditions Subsequent (CS’s) and Why can such CP’s be closed post closing, In an Investment Transaction?

This article is a part of a series called “Understanding the Nuances of Signing and Closing In Investment Transactions”.

Last week we discussed:

• Why are legal, financial, tax and technical diligences (if applicable) undertaken in an investment transaction;
• What is the meaning of conditions precedent, in an investment transaction;
• Why is an investment agreement signed and executed before any conditions precedent are required to be fulfilled by the start-up; and
• Why conditions precedents are required to be completed (to the satisfaction of the investor(s)), prior to closing of an investment agreement.

You can read the article here.

This week we aim to discuss exactly what is the meaning of the term conditions subsequent (“CS’s”) and why can such conditions (a) not be included in the list of conditions precedents; and (b) can be completed post-closing of an investment agreement.

“The following entrackr link: Funding and acquisition in Indian startups this week [04 Apr-09 Apr], states in its introductory sentence that – “This week 27 Indian startups raised funding, of which 22 received a total of about $955.14 million”.

Now, let’s try to understand the above statement from a closing perspective in investment transactions, i.e., to understand the conditions required to be complied with, by the startups, post receiving funding from their investors, on the closing date.

In any investment transaction, generally a financial, legal and if required a technical due diligence is undertaken by the advisors of the investors. The due diligence reports generated post completion of such diligence(s) generally provide for a list of issues (financial, legal, tax etc.) that are discussed between the company and the investors, and later negotiated along with their relevant advisors.

As there are a myriad variety of issues that arise from the said due diligence(s), the ones more critical to the investors are generally included in the investment agreement as conditions precedent or commonly referred to as the “CP’s”. The remaining issues that arise from the said due diligence(s), the ones less critical to the investors are generally included in the investment agreement as conditions subsequent or commonly referred to as the “CS’s”

As these CS’s:

(a) are less critical in nature from an investors(s) perspective;

(b) can be negotiated between the investors, promoters and company to postpone these non-critical issues from CP to CS, with the help of their legal advisors;

(c) generally, require a very long-period of time (approximately more than 6 months) to be completed; and

(d) conditions that can only be fulfilled post receiving funds from the investor(s).

Hence, as a first step, to ensure that all parties to the investment agreement are contractually bound by its terms, the investment agreement is signed/executed by all parties to be bound by the terms of the investment agreement and to undertake all actions therein.

This next step, post signing/execution, is for the company and the promoters to complete the CP’s to the satisfaction of the investor(s).

As the time period required to ensure completion of the CPs to the satisfaction of the investor, is the very time period between the signing date and the closing date, certain clauses are included in the investment agreement, for the company to maintain its status-quo (financially and otherwise), to ensure that the company operates as per its ordinary course of business.

Once the CPs are successfully closed to the satisfaction of the investor, the parties then proceed to close the investment agreement.

As a final step, post the company receives the funding by the investor(s), the company and the promoters then proceed to complete the CS’s.

Once, all the CS’s are closed by the company and promoters, to the satisfaction of the investor, only then can all terms of the share subscription agreement, i.e., terms to be satisfied by the company and the promoters, linked to the funding to be received and post-receipt, can said to be completed.

Hence, whilst the CP’s are terms that are subjected to receipt of funding by a company. The CS’s are terms that are required to be completed, post receipt of funds by the company, from its investor(s).

Hence, basis the above understanding now, let’s revisit the statement from the link above:

“This week 27 Indian startups raised funding, of which 22 received a total of about $955.14 million.”

So now when we read the above statement, we can understand that – this week 22 Indian startups successfully completed the conditions precedent in Investment Agreement, to the satisfaction of their respective investors, to receive funding, in lieu of the said startups issuing securities to their investors. However, there still may be certain terms (CS’s) that the company may be required to complete, post receiving the funding, for the share subscription agreement to be closed and all terms to the investment, satisfied.

This article is a part of a series called “UNDERSTANDING THE NUANCES OF SIGNING AND CLOSING IN INVESTMENT TRANSACTIONS”.

Stay Tuned for the next part where we will discuss how are conditions precedent and subsequent decided in an investment transaction, if the funding is to be received by the company from its investor(s), in tranches.