When fundraising during Covid-19, consider these tips before signing the contract

The unprecedented crisis caused by Covid-19 has altered global economic activity.

Investors, like everyone else, are affected too: Angel investors are likely to be distracted from doing deals and VCs might feel cautious about deploying capital. All these lead to less cash for startups.

Photo credit: Mentatdgt

If your startup is in the middle of raising capital, here are things to consider, depending on the stage of the fundraising process you’re in.

If you have a term sheet

The most important thing to remember is that a term sheet is nonbinding. While investors do not typically sign term sheets and then withdraw for market reasons, we are in unusual times. Investors can walk away without any reason, which can cause major disruption to a fundraising process.

If you are in the process of receiving and negotiating term sheets, a good tip is to keep any exclusivity period to a minimum, e.g., no more than 30 days. Thus, if an investor starts to waver, the company can move on quickly to other opportunities.

Another tip is to structure the deal in a way that it can be closed quickly. Consider limiting the number of investors and instead keep existing shareholders up to speed so paperwork can be executed without delays.

If you’ve signed an investment document but the deal is yet to be completed

While investors are legally bound to close a deal and fund a company once they have signed on, share subscription agreements always include a clause that makes the fulfillment of an investment contingent on certain conditions.

These conditions often involve a provision for material adverse effect (MAE), which essentially allows investors to withdraw from a fundraising deal should there be a change that impacts a business or its financial performance in a material way.

Such clauses do not just cover deterioration in the financial performance of the business, but also include almost anything that materially affects its operations: termination of a key license, a change in the law, or a company’s inability to deliver services as before.

The pandemic is, of course, affecting not just economic activity but is also forcing governments to implement new measures on a daily basis, so whether Covid-19 could be cited as an MAE trigger depends on how a provision is drafted.

How big of a deal is an MAE in a fundraising transaction? It’s possibly not a major concern in the case of startups and fundraising deals.

Unlike mergers and acquisitions where there are often long periods between signing and closing, investors and startups tend to wrap things up quickly when financing deals.

Signing and completion usually occur simultaneously or within a few days of each other, leaving little to no time for an investor to withdraw on the basis of an MAE. The exception is when there is a “rolling close” on financing deals, i.e., further money would be invested after a period of time.

Other tips to consider when fundraising during a crisis