The private equity investment process

The author Peter Adediran is a UK qualified and fully licensed current practising solicitor specialising in assisting technology start-ups from making the shift to corporate clients and institutional investment candidates. His breadth of experience over 10 years means that he has been an important influence in helping technology start-ups improve aspects of their business that have had a significant impact on the personal lives of their founders

Getting private equity investment from an investor that is either an institution or a sophisticated investor is gold dust for start-ups. Investment from an investor with knowledge or expertise in your business idea is a great validation of your business. Although it does not mean that your idea will be a success it does help to boost confidence in your idea. Outside investment from a sophisticated investor demonstrates that you are not alone in believing in your value proposition. However, preparing your business for a private equity investment is not straight forward if you have not been through the process before.
So, once you have investor commitment how do you receive the funds?
There are 2 ways to facilitate the private equity investment:
1. You issue new shares in the company;
2. Transfer existing shares in the company.
1. Issuing new shares in the company
The first thing is to check the articles of the company. Generally, if they are Model Articles you will to need amend the articles of association.

Generally, directors need authority by the shareholders to allot new shares. You need to see what procedure your articles have prescribed for the issue of shares in your company. The Model Articles state that 2 directors and shareholders form a quorum. You might need to change this. It will also be a good idea to have a shareholder’s agreement the investor agreeing the procedure for meetings and reaching agreement on running the business.

Some of the issues you want to resolve are:

1. Who can form a quorum for a shareholders meeting or directors’ meetings?
2. Rights to appoint and remove directors?
3. Do you need unanimous shareholder approval for certain decisions?
4. Restrictions on freedom to dispose of shares and, if other shareholders have pre-emption rights, at what valuation such transactions should take place. A minority stake in a company is usually powerless, so the value of the minority shares will be correspondingly reduced. This can be over-ridden in favour of treating all shares as ranking pari-passu.
5. Any other restrictions on directors’ authority such as changing the nature of the business?
6. Any terms regulating the raising of capital to avoid diluting existing shareholdings?
7. Dividend policy. You can waive temporarily or permanently investor dividends rights
8. Limitations on shareholder to charge the shareholding?
You need to find out how much involvement the investor wants in the day to day management of the business. You also need to look at this for future investments. How much involvement do you want from investors as they come in?
The problem with issuing new shares is dilution. If say you have 10 new shares in company A all owning a single share (every shareholder has 10%). You then decide to issue 10 additional shares to Mr X for 50% of the business. You have diluted the value of the original 10 shares in the company by 5% each. That means each original shareholder has relinquished 5% of their control.
You should consider the potential loss of control of your company from issuing new shares.
Pre-emptive Rights to New Shares
The articles will set out any applicable pre-emption rights. Pre-emption rights require that the existing shareholders get the right of first refusal in proportion to the rights they already hold.
Model Articles contain pre-emption rights for the issue but not the transfer of shares. You will need a special resolution to change or disapply them. Special resolutions can be passed in general meeting or through a written resolution. Pre-emption rights may also be waived by waiver letter.
Sub-division of shares
You will need to cover the subdivision of existing share capital before issuing new shares.
Say you have 10000 shares of £1 each nominal value. If you subdivide the shares to 1m shares of £0.01 each you still end up with a nominal value of £10k. You will need to pass an ordinary resolution and file a statement of capital form at Companies House.
You then allot the new shares. The money from the investor is paid over Once the money for the shares is received the shares will be issued.
Documentation administration
1. Share certificates are issued
2. Companies House SH01 form (statement of capital) filed at Companies House within one month of the share issue.
3. Any ordinary resolutions; special resolutions must be filed at Companies House.
4. Shareholder resolutions must be filed at Companies House within 15 days of being passed; and
5. Update the register of members in the statutory books.
2. Transfer existing shares in the company.
Transfer of shares
The problem with a transfer of shares regarding raising private equity finance is the exposure to capital gains tax. Capital Gains Tax (CGT) is usually the difference between what you paid for an asset and what you bought it for. Transferring your shares can result in a substantial hit especially if the premium value of the shares is much higher than the value at which you purchased them. Of-course there are ways to reduce the CGT hit such as assessing the pre-investment asset by market value. You can deduct what you paid for stamp duty, valuation fees, VAT (if you cannot reclaim it), eligibility for reliefs.

My general view would be that it might become very difficult to keep control of your business if you keep issuing additional shares. I would only recommend transferring shares to take on fresh private equity investment where you already have a share register that is increasingly difficult to manage.

Documentation administration

1. To transfer shares new share certificates will have to be issued. You will have to sign indemnity letters against the old share certificates.
2. You need to execute the J30 stock transfer form.
3. Lastly you will pass board resolutions and sign the board minutes.
4. It is normally necessary to pay stamp duty on the transfers to legalise them however stamp duty is not payable if the shares are transferred as gifts (in other words there is no consideration).
5. You will require a set of statutory books. Within the statutory books all the stock transfer forms must be filed and the register of members updated. You do not have to file any forms at Companies House at the time of the transfer, but you will have to record the share transfers when you file an annual return.

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