Understanding Contracts to Protect Your Investment

July 19, 2021

Contracts are an essential part of business and commerce. They can protect your livelihood, your assets, or the financial investments you have made. Contracts are drafted for a variety of…

Contracts are an essential part of business and commerce. They can protect your livelihood, your assets, or the financial investments you have made. Contracts are drafted for a variety of reasons, including:

  • Contracts for Services
  • Employment Contracts
  • Vendor Contracts
  • Partnership Contracts
  • Independent Contractor Contracts
  • Investment Contracts

Across these different categories, contracts provide the legal documentation required for the enforcement of promises. For instance, if you enter into a contract with an independent contractor to complete a website redesign, that entity has a duty to uphold all of the expectations outlined within the contract. A failure to do so may result in financial losses for your company. But a contract can shift some of the legal liability for those losses from your business to the individual who breached the contract terms. This example is only one of many instances in which a breach of contract can protect your assets.

Investment contracts specifically address instances where one party invests money with the expectation of receiving a return on their investment, or ROI. Small business owners or startups may use investment contracts when they bring outside investors into their business. This funding is usually used to promote the growth of the company. But when investors provide these funds, they often expect that the company will deliver a share of its profits across future transactions. This arrangement is the price that the original company must pay to access capital immediately.

No matter what type of contract you may have to establish, it’s vital that you understand it completely. A failure to understand every aspect of the contract can result in a violation of the contract terms, which could result in a financial loss that may not be protected as well as you thought it was. Or there could be a clause or other language that nullifies the agreement in certain circumstances. For these reasons, you must have a comprehensive and in-depth understanding of all contracts before agreeing to them, including investment contracts.

Investment contracts can be tailored to meet many unique requirements of the company and/or the investor. Despite this, the federal securities laws define investments contracts by four elements; they are the 1) investment of money; 2)in a common enterprise; 3: with an expectation of profits; 4) solely from the efforts of others.

Given this definition of investment contracts, these documents often include the following core elements:

  • Parties: This section frequently includes shareholders, owners, or investors. In any instance, it would include those parties that conduct the transaction.
  • Adherence Clause: An adherence clause, or deed of adherence, outlines the future transfer of stock as required under the same terms and conditions of the investment agreement. This clause binds the new shareholder to the terms of the contract.
  • Investment Tranches: Investment tranches allow the investor to provide partial payments as the company achieves certain targets or milestones, such as the launch of a new product or the achievement of a revenue target. This type of strategically structured finance deal can mitigate some of the risks for the investor.
  • Investment Warranty: A warranty within an investment contract requires the company to verify that the statements made by the company are true and accurate. This warranty often covers documents provided to the investor, including financial information, product information, the company’s share capital, and any outstanding liabilities, litigation, and taxes.
  • Disclosure Letter: A disclosure letter may be included in an investment contract, which allows the company to provide information about all potential issues that may impact the company’s ability to operations. Disclosure letters can include information such as potential lawsuits, liabilities, risks, conflicts, or other information that may be required by the investor.
  • Investor Rights: Investors often have many rights outlined within investment contracts, such rights related to the initial public offering, the sale or transfer of shares, management reports, financial statements, board observation, rights of refusal, and rights of preemption.
  • Restrictive Covenants: Restrictive covenants may be put in place to limit the shareholder’s ability to sell or transfer his or her shares in the company to ensure key personnel remains after the investment is made.
  • Board Representation: Investors may outline in contracts that they demand one or more directors on the company’s board.
  • Exit Strategy: An investment contract may also outline the timeline or work towards a possible exit of the investor.

As you can see, investment contracts – like all business contracts – can become complicated quickly. And these complex legal documents must be crafted very carefully to ensure they provide the protection intended. For additional information on understanding contracts as a way to protect your investment, contact the commercial litigation experts at Grellas Shah.