What Happens Between Funding Tranches, 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:

• meaning of the term conditions subsequent (“CS’s”) in an investment agreement;
• what separates any issue from becoming a condition precedent (CP) or a CS;
• reasons as to why CS are required to be closed post closing; and
• steps leading from execution date to closing of all terms subjected to funding, in an investment agreement.

You can read the article here.

This week we aim to discuss exactly what happens to these CP’s and CS’s and what other changes are standard in an investment agreement if, the funding is to be received by the company from its investors, in tranches as per the investment agreement.

“The following entrackr link: Funding and acquisition in Indian startups this week [11 Apr-16 Apr], states in its introductory sentence that – “This week 37 Indian startups raised funding, of which 32 received a total of about $806.21 million.”.

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

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), certain issues identified in the said due diligence(s) either require (a) a long time period of time to close such issues; and/or (b) an approval or clarification is required from a governmental authority; and/or (c) the amount of funding is a large sum and the investors wish to invest in parts – to have an option to either invest on completion of specific identified milestones post the initial funding and, to have the option to not invest in subsequent tranches if such identified milestones ae not completed to the satisfaction of the investor(s).

In any investment transaction, issues specific to the company, its investors, the sector it operates in, will always define the terms of the investment agreement and are hence always highly negotiated between the company, the investors and the advisors.

Hence, the result of the round(s) of discussions in relation to the issues in the due diligence report between the companies the investors and the advisors, will decide if any conditions are:

• required to be fulfilled by the company prior to execution of the investment agreement;
• required to fulfilled by the company as CP’s post execution, of the investment agreement;
• if the funding should be in one tranche or two tranches, or multiple tranches;
• what CP’s should be included before which tranche of funding;
• what CS’s should be included post which tranche of funding; and
• when and basis what conditions, should the funding be deemed to be fully completed.

Such terms are finely negotiated in an investment agreement to ensure that all parties to the investment agreement are contractually bound by such terms, once signed/executed by all parties.

Once, all the CS’s for all relevant tranches 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 in tranches and post-receipt, can said to be completed.

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

“This week 37 Indian startups raised funding, of which 32 received a total of about $806.21 million.”

So now when we read the above statement, we can understand that – this week 37 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, from the statement above, we also understand that the funding amount received by the startups, may only be one of the many tranches of funding – to be received/or previously received, by the company in a round of investment.

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

Stay Tuned for the last part where we will take questions from any of our previous parts of this series and, what is next post signing and closing of an investment agreement.