When raising funds for your company, there are certain steps that you can take both before and during the fundraising exercise in order to smoothen the process. This article provides some general and practical guidance to start-up companies looking to raise funds as well as a brief overview of the key legal documents that you will likely encounter.
Be prepared
Before embarking on a fundraising round, it is important to get your ducks in a row. As part of your preparations, you should have ready some basic core materials that any potential investor will typically expect to see during the due diligence stage such as:
Having a set of well-prepared core documents at the outset can help you in making a good first impression on investors and by expediting the due diligence process (more on this below).
Term sheet
A term sheet (also known as a letter of intent (LOI), memorandum of understanding (MOU) or heads of terms) is by no means mandatory (some just go straight to drafting the final contracts), but it does feature regularly in transactions as a means of recording the principal terms on which the investor(s) will, subject to the satisfaction of any mutually agreed conditions, invest in the target company.
Generally term sheets are not binding on the parties except for certain provisions such as confidentiality and the governing law clause. Nevertheless, it is an important document because it sets the basis and tone for the negotiation and drafting of the definitive transaction documents and, once signed, the investor(s) may be reluctant to deviate from the agreed terms. Therefore, you should consider having a lawyer review your term sheet before signing it. In addition, you should also pay attention to any exclusivity clauses which could restrict your ability to approach or otherwise deal with other potential investors.
Due diligence
Due diligence is the process by which a third party investor obtains information and documents about a target company (including financial and legal information and documents). Seasoned investors will usually kick-start the process by sending their preferred form of due diligence questionnaire to the company’s management and/or representatives who must then provide the requested information and documents in the agreed manner and, if applicable, by the agreed deadline. Generally speaking, the due diligence process becomes lengthier and more complex with the maturity of a start-up company. In contrast, due diligence should be a relatively straight-forward exercise with younger start-up companies.
As mentioned above, advance preparation of core documents can greatly assist in expediting the due diligence process. Insofar as the legal due diligence is concerned, a start-up company which is incorporated in Hong Kong should be prepared to provide the following corporate information and documents when requested by an investor:
The above list is not exhaustive and will be tailored to suit the circumstances including the potential investment amount, the sector in which your start-up company operates, and the maturity of your start-up company.
After you have responded to the investor’s due diligence questionnaire, you may receive further rounds of follow-up questions and requests. You should answer them honestly and avoid withholding information for fear of scaring off the potential investor. Most issues are capable of being resolved or managed from a risk allocation perspective. For more complex requests concerning legal issues and documentation, a lawyer can assist you.
Involving a lawyer in the legal due diligence process is helpful when it eventually comes to negotiating the representations and warranties to be given by the company and/or the founders to the investor.
The transaction documents
If you have cleared the due diligence stage, the next step is to negotiate, agree and execute the transaction documents. Each round of investment is usually labelled as a ‘Series’ (such as a Series A Investment) with the earliest rounds being labelled as ‘Seed Round(s)’. Institutional investors will usually invest in the equity of your start-up company (though there are different types of investment), which means that such institutional investors will become shareholders of your start-up company. In an equity investment involving a subscription for shares, the transaction documents will generally include a subscription agreement, a shareholders’ agreement (or, as the case may be, an amended shareholders’ agreement) and amended articles of association.
A subscription agreement, as the name suggests, is the contract that governs the terms for subscribing for new shares that will be issued by the start-up company. Such an agreement would contain key terms for the subscription such as subscription price and the number of shares that will be subscribed. A subscription agreement will also set out representations and warranties about the start-up company and, where relevant, its subsidiaries. Contractual warranties are statements made by a person (whether that person be a founder, the start-up company, or the relevant subsidiary) in favour of an investor (or the investors) about the conditions of the relevant company to which the warranties relate. The main purpose and effect of such warranties is to impose legal liability upon the warrantor making such statements and to provide the investor with a remedy if the statements made about the relevant company prove to be incorrect, and the value of start-up company thereby reduced (i.e. where the investor suffers a loss). As an investor will have direct recourse against the person who gives the warranties, it is not uncommon to request a subsidiary of the start-up company, that owns the relevant assets and operates the actual business, to be a party to the subscription agreement and to give warranties.
The shareholder rights of an institutional investor are usually different from (and usually better than) that of a founder. For instance, an institutional investor may request that certain critical matters (commonly known as reserve matters) can only be carried out with the consent of such investor. An investor may also ask for liquidation preference where their rights to a distribution of assets of the company will rank ahead of an ordinary shareholder (e.g. the founder). Different shareholder rights can be distinguished by different ‘classes’ of shares. Usually institutional investors’ shares that have better rights are called ‘Preferred Shares’. The rights of the shareholders are usually set out in the articles of the start-up company and the shareholders’ agreement. The model articles that are prescribed to a Hong Kong company at its incorporation do not provide for a separate class of shares, and would need to be amended in order to accommodate an investor’s request for different class rights. It is also important to amend the articles so that they are consistent with the terms of the shareholders’ agreement. A failure to do so may cast doubt on the enforceability of a specific right or obligation to the extent that there exists any inconsistency.
A lawyer can guide you through the entire fundraising process and advise you on the legal risks and implications of the terms of your transaction. For more information on fundraising and how MinterEllison LLP can assist you, please contact George Tong or Caroline De Souza.
The Government introduced the Financial Reporting Council (Amendment) Bill 2021 (the “Bill”) into the Legislative Council for scrutiny on 21 July 2021.
At present, the Financial Reporting Council (“FRC”, which according to the Bill will be renamed as the “Accounting and Financial Reporting Council”) serves as the independent regulator of auditors of public interest entities (“PIE”) and exercises powers of inspection, investigation and discipline over PIE auditors and their responsible persons in relation to their engagements for listed entities. Meanwhile, practice units and certified public accountants (“CPAs“) are, in general, regulated by the Hong Kong Institute of Certified Public Accountants (“HKICPA“) in all other respects.
The Bill seeks to extend the FRC’s regulatory functions to cover all practice units and CPAs by transferring certain regulatory powers currently exercised by the HKICPA to the FRC. These include proposals to:
Under the proposed regime, the HKICPA will continue to discharge various functions under the oversight of the FRC, including registering individuals as CPAs, ascertaining qualification for registration as CPAs by conducting examinations, arranging for mutual or reciprocal recognition of accountants, setting requirements for continuing professional development, setting accounting, auditing and ethical standards, and providing training.
The Bill is currently being considered by the Bills Committee of the Legislative Council, which is inviting interested parties to make submissions on their views regarding the Bill, with a closing date of 3 September 2021. For further information about the Bill, please refer to the Legislative Council website.
Launch of Anti-Sexual Harassment Hotline
With the widespread development of the #MeToo movement and additional funding from the Government, the Equal Opportunities Commission (“EOC“) established the Anti-Sexual Harassment Unit (“ASHU“) in November 2020 to strengthen efforts in combating sexual harassment through prevention, research, policy advocacy, policy guidance and training.
On 25 January 2021, the EOC announced the launch of the Anti-Sexual Harassment Hotline (the “Hotline“) operated by the ASHU, the goal of which is to provide a first port of call service to the public with information on provisions of the law, advice on where to lodge complaints of sexual harassment and seek redress, and referral to counselling and therapy services.
The introduction of the Hotline is a clear indication of the Government’s increasing emphasis on combatting sexual harassment in the workplace. As such, it is vital for employers to take all reasonable actions in line with the government’s initiative.
Employers should review, and where necessary, revise their internal policies and handbooks to ensure that adequate anti-harassment policies are in place to both prevent and handle sexual harassment in the workplace. Such policies should be extended to protect non-employees, such as independent contractors (e.g. consultants or workers on secondment), interns and volunteers. Regular training should be conducted on the policy to ensure that both management personnel and employees are well informed of the company’s anti-harassment policy, and are aware of the internal complaint-lodging platforms and investigation procedures. Moreover, employers should handle with caution when imposing appropriate disciplinary sanctions (such as suspension or summary dismissal) against an employee under investigation or found responsible for harassment to ensure that any such sanctions are imposed in accordance with the law. Other legal issues that employers should also be aware of include the proper collection and handling of personal data during the course of an investigation in accordance with the Personal Data (Privacy) Ordinance, as well as the safeguarding of the confidentiality and anonymity of the parties involved.
Sexual harassment complaints expose employers to potential legal claims, and may also have serious implications on an employer’s reputation, company culture as well as morale. Employers should therefore ensure that sexual harassment complaints are promptly and properly handled with a proactive approach.
This year the Government proposed to bring into operation the new inspection regime under the Companies Ordinance. The subsidiary legislation relating to implementation of the new regime (“Subsidiary Legislation“) was gazetted on 18 June 2021 and tabled at LegCo for negative vetting.
The key feature of the new regime is the restraint on public access to the usual residential addresses / full identification numbers of directors and company secretaries (collectively, “Protected Information“). Instead, their correspondence addresses / partial identification numbers would be made available for public inspection.
Certain specified persons may apply to the Registrar for access to Protected Information. Upon such applications and subject to meeting the requirements under the legislation, the Registrar may disclose the Protected Information to the specified persons. Examples of specified persons are a member of the company, a solicitor, a CPA (practising) and a financial institution.
According to the proposed timeline, the new regime will be implemented in three phases:-
On 16 July 2021, the Chairman of the Subcommittee on the Subsidiary Legislation indicated that the Subcommittee would not propose any amendments to the Subsidiary Legislation and would submit a written report in due course.
Full texts of the Subsidiary Legislation are available here.
The changes to the Listing Rules relating to disciplinary sanctions and powers (Disciplinary Related Rules Changes) came into effect on 3 July 2021. Shortly after the Disciplinary Related Rules Changes have come into effect, The Stock Exchange of Hong Kong Limited (HK Stock Exchange) published a revised Enforcement Policy Statement (Policy Statement) and a revised Enforcement Sanctions Statement (Sanctions Statement) on 8 July 2021. The Policy Statement and the Sanctions Statement reflect both recent developments and the HK Stock Exchange’s view of current enforcement priorities.
There are three enforcement priorities specifically set out in the Policy Statement: (1) responsibility; (2) controls and culture; and (3) cooperation. To further elaborate, (1) responsibility refers to the key priority behind the HK Stock Exchange’s enforcement actions, that is to ensure that those individuals who are responsible for discharging duties in connection with listing matters, and those who are culpable of failures and misconduct, are held to account; (2) controls and culture includes as a minimum the implementation of appropriate and effective internal controls and extends to the culture of the company, and the attitude towards compliance and corporate governance; and (3) cooperation is a straightforward concept: failure to respond to or cooperate with the HK Stock Exchange when there is a duty to do so will be viewed as serious misconduct.
The Sanctions Statement, which is a statement on the principles and factors in determining sanction, has been updated to reflect the Disciplinary Related Rules Changes. For example, whether there was wilful or persistent failure by the issuer to discharge its responsibilities under the Listing Rules is no longer a matter which will be considered before deciding that facilities of the market be denied for a specified period since the threshold of “wilful or persistent” failure has been removed under the Listing Rules.
For more details, please refer to the revised Policy Statement here and the revised Sanctions Statement here
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