Venture Financing Deal Process 101 — Path to Closing
An overview of the process of venture financing deals and how HyperDraft can help lawyers save time and maximize value for their clients.
This article is one of a series by HyperDraft on the process of a venture financing deal. Deals are busy and often the basics are glazed over in practice. Our team has been there practicing in the trenches and understands the need for quick refreshers. This series aims to quickly fill in the blanks with a brief overview of common topics.
Big Picture — Why Do Companies Raise Venture Capital?
A company rarely has much proof of concept when starting out, making startups risky investments. Traditional debt financing sources are often unavailable or too expensive to be a viable option; therefore, most startups look to family and friends or angel investors to get the company off the ground. Venture capital is attractive to emerging companies because they have more capital to deploy than friends and family and angel investors and they don’t require hard assets as collateral or repayment like traditional sources of debt.
Venture firms fill the gaps in other sources of financing, but they have to raise capital before they can invest in emerging companies. The investors in venture capital funds are routinely very large institutions (i.e. pension funds, financial firms, insurance companies, and university endowments, etc.) that expect a return of between 25% and 35% per year over the lifetime of the investment. As a result of this expectation, venture capital is not long-term money. Venture firms make investments in companies with the hope that they can guide their selected companies to a profitable exit (i.e. initial public offering, sale to private equity firm, etc.) which provides a return to their investors.
Venture firms need to ensure their investments abide by various tax laws and other regulations which are relevant to their investors. As a result, venture financing deals are not handshake deals, but rather require thorough diligence, drafting, and negotiation. The path to closing usually requires teams of lawyers on both sides of the transaction working through a collaborative yet adversarial process.
Steps in the Venture Financing Process
As we discussed in our series on venture financing term sheets , the first step in any venture financing is the finalization of a term sheet. A term sheet memorializes the underlying business deal and is used as the blueprint for the transaction. With term sheet in hand, the lawyers on both sides of the transaction begin the process of (i) conducting due diligence, (ii) drafting the transaction documents, and (iii) negotiating the remaining open points. In this article, we are going to provide an overview of the steps to kick off and close a venture financing. We will dive into the process in greater detail in future articles.
On average, it takes a team of lawyers 25–60 hours to close a venture financing transaction, depending on the stage and complexity of the deal and whether the legal team represents the company or the investors.
- Initial Drafts
In practice, lawyers rarely draft documents from scratch, but start from an agreed precedent or a form previously used by their firm. The documents are updated to reflect the party details, business terms and other relevant information for the transaction at hand. Despite the use of precedent, this process is time consuming and can require numerous attorneys drafting and editing multiple versions of each document internally before any draft is shared with the client or opposing counsel. In a venture financing, company counsel ordinarily will take 10 to 15 hours to draft the initial transaction documents.
2. Negotiation
After the initial drafts are finalized, the documents are sent to opposing counsel. Opposing counsel will then review the drafts and redlines to create a list of issues to discuss with their client and will incorporate any feedback. Opposing counsel will then send the marked-up documents back to the other counsel who will conduct the same review process. Both sides will continue to trade drafts of the documents until all parties are agreed. The amount of time this negotiation takes depends on the number of turns of the documents. Each turn takes about 4 to 5 hours so if the parties exchange 3 drafts, then this process can take anywhere from 8 to 15 hours to complete.
3. Ancillary Documents
Ancillary documents (“Ancillaries”) are certain agreements that are required to close a venture financing, such as consents authorizing the transaction and officer certificates, but do not contain the main deal terms. The process to finalize the Ancillaries is almost identical to the process to finalize the main documents. Drafting Ancillaries takes approximately 4 to 10 hours, but varies depending on the industry the company is in or other extenuating circumstances.
4. Due Diligence
Investors want to know what they are investing in; therefore, a venture financing will include a due diligence review of the company. Investor counsel will review documents regarding the company’s formation, governance, and equity structure. They will also review vendor and customer agreements and employee documentation. Investor counsel will request and review any other documentation that they think is necessary depending on the company’s industry (i.e. documentation regarding HIPAA compliance for healthcare startups). Investor counsel will discuss their findings with their client and this will inform their negotiating position. On the flip side, company counsel will conduct “reverse due diligence” to determine what needs to be disclosed to the Investor in a “Schedule of Exceptions” to the representations and warranties made by the company.
5. Prepare, Send and Collect Signature Page Packets
Once the documents are finalized and due diligence has been completed, the documents need to be signed. Although this seems like a simple task, it takes hours to complete depending on how many parties are involved. Company counsel determines which parties need to sign which documents and separate each party’s signature pages including their specific signature blocks and signatory details into a separate packet for them to sign. Company counsel then distributes the packets to the parties for signature, collects them back, and compiles them into the documents to create the executed copies. This process will start at least a week before the anticipated closing and signatures received before the closing are held in “escrow.” Once the documents are in agreed form and all packets are collected, the parties release their signatures to “sign” the agreement.
HyperDraft — a Low Effort, High Impact Tool to Hack the Venture Financing Deal Process
When teams use HyperDraft, they can shave hours off of each step of the path to closing. This time savings can create more time for teams to find creative solutions and go the extra mile in negotiation for their client’s overall goals. The job of a lawyer can be hard and thankless because lawyers are often tasked with doing a near impossible amount of work for multiple clients under ambitious timelines. It is hard for lawyers to operate at their best when stretched for time, resources, and energy. We have created tools which can help lawyers save time on the more mundane tasks so that they can use that time to flex their expertise, gain valuable experiences and skills, and provide greater value to their clients.
At HyperDraft, we are building the ultimate toolbox for lawyers. We have assembled a team of legal experts with decades of real world experience to build practice modules that reflect the workflows of lawyers. As a result, HyperDraft can be integrated seamlessly into active teams and their deal flows. We realize that time is a lawyer’s most valuable resource, so adopting HyperDraft is a low-effort and seamless process. Our team of lawyers and engineers code and customize our tools to suit the needs of each team.
Tying It All Together
Venture capital provides emerging companies with capital and resources to grow, but the path to closing a venture financing can take considerable time and resources. HyperDraft is a low-effort, high impact tool which can help teams streamline the process and maximize their time. Join our waitlist to use HyperDraft as your secret weapon.
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