Investing and allocating capital
What Rights Should an Investor Understand Before Buying Shares in a Private Company?
Short answer. Understand the rights tied to the shares, including voting and board access. Review preferences, participation rights, pre-emptive rights, and conversion and transfer terms. Check the capitalization and related agreements to see how your position could change in later financing or an exit. Have your own qualified legal counsel review the documents before you commit.
Before buying private company shares, understand the rights attached to the security and how the agreements affect your position. A term sheet may outline economics and governance provisions, while other rights appear in several documents. Read the documents together and ask your own qualified legal counsel to review them before signing.
Understand the Share Terms
Confirm the number of shares offered, their price, and whether they are common or preferred. Review preferences that determine who receives proceeds first, along with participation rights and pre-emptive rights. Check conversion terms, whether you can join future offerings to maintain your ownership, and what happens if you do not.
Ask what voting rights come with the shares and whether you have board or observer rights. For a minority investor, access to information and the ability to raise concerns can matter, as can participation in certain decisions. Check for veto rights over specified actions and determine whether those rights belong to an individual investor or a group. The rights available to non-controlling investors should be clear in the documents.
Review the Complete Document Set
Request the current capitalization table or share register. Confirm how the proposed issuance fits with existing shares and options, as well as other securities. Review the private placement materials and the subscription or stock purchase agreement. Read any shareholder or investor rights agreement. Other documents may govern voting, transfer restrictions, indemnification, or the company's charter. Check that the final documents match the terms you understood during negotiations.
Pay attention to transfer provisions and confidentiality obligations, along with payment terms. Check for restrictions that could affect a future sale. Ask how the company expects to handle a sale, new financing, or disagreement among shareholders. Rights have practical value when you understand the conditions and process for using them. A minority investor's protections should be considered alongside the company's governance and financing plans.
Consider How the Rights Work Over Time
Later rounds, amendments, or a change in control may affect your rights. Find out whether new investors can receive terms senior to yours and how future fundraising could dilute your ownership. Ask what happens if the company needs more money and you cannot or choose not to invest. Examine exit provisions and limits on transferring shares.
A favorable term sheet may leave questions unanswered. Compare it with the definitive agreements and resolve inconsistencies before funding. Talk with your attorney about legal provisions and your CPA about tax issues. Keep an executed copy of each agreement and a record of the share issuance in the family's files. The investment records to keep should make the family's ownership and obligations easy to confirm.
A term sheet covers how many shares are being offered, the price per share, common or preferred share status details, preferences, pro- rata rights, participation rights, pre-emptive rights, conversion rights, and board rights.
Sources: The Single Family Office. Informational only, not financial, legal or tax advice.