Founder’s Guide to Equity Investment Agreement
In this article, we will understand equity agreement importance, applicability, implementation, pros and cons of equity agreement.
It is often said that we invest for the long term when we categorize different businesses. We understand how important it is to be able to provide value by increasing profit. Similarly, investors make sure that they always take less risk. So they invest in equity shares which helps them drive more profit. These days, equity is the most expensive asset for a company, but it is worth keeping.
Equity, also known as shareholders’ Equity (or owners’ Equity in the case of privately held corporations), is the amount of money that would be returned to a company’s shareholders if all of the company’s assets were liquidated, and all of the debt was paid off in the event of a liquidation. In the case of an acquisition, equity is the company’s revenue after deducting any obligations due by the company.
What is an equity agreement?
When investors agree to donate money to a company in exchange for the chance of a future return on their investment, this is known as an equity investment agreement. Due to affluent investor partners and no repayment schedule, equity is one of the most appealing financial sources for entrepreneurs. It does, however, need the most effort to find. When you raise money through equity, investors give you money in exchange for a piece of the firm, which will theoretically increase in value as your company grows.
Any stock option agreement between the corporation and a selected stockholder entered into pursuant to an equity plan is referred to as an Equity Agreement. An equity agreement is like a partnership agreement between at least two people to run a venture jointly. An equity agreement binds each partner to each other and makes them personally liable for business debts. When two partners sign the equity agreement, each partner is responsible for each other’s actions. The share might not be the same in the equity agreement but the roles and responsibilities of each partner remain the same.
For example, if one partner is handling the entire management, the other partner must be responsible for running the operations of the business.
Why is an Equity Agreement important?
An Equity Agreement is done to ensure that both the investors and company can stay together for an extensive long duration of time.
The significance of an equity agreement could be broadly summarized as below:
- Long-term commitment from the founders – Sometimes there are ups and downs, and some of the founders might start losing interest and don’t want to work together. They have limited capital and extensively high reliance on the founder’s efforts to work and stabilize the company. Signing an Equity Agreement makes it convenient for them to stay motivated and continue their efforts to grow the business.
- Damages from the founders – While signing the agreement, there are some terms to be kept in mind that might create hurdles in the future. There is a clause where if one founder passes away after a certain period, a new company can jeopardize its future success. But without the equity agreement, this can’t be possible in case the company might face losses.
- Protection of Investors – Before committing to an investment, professional investors – venture capital firms or angel investors – commonly demand stock vesting provisions from founders and key personnel. It’s a technique of determining how invested people are in the company, as well as protecting equity from departing partners.
When is an Equity Agreement applicable?
It is often done in the early stages of a startup as the company strives to align all of the founders’/critical talent’s incentives with the company’s. Typically, stock vesting is done over four years with one-year cliffs, i.e., if a person has 50% equity and quits in two years, the firm forfeits 25% of that equity. The one who stays longer with the company, the more equity vests. In this situation, if one stays for the entire tenure, the entire stock vests, rewarding the employee for sticking with the company for such a long time.
Pros and Cons of Equity Agreement
Investing in equity shares has always been expensive for companies, but if it is invested with proper information and knowledge, it can always be helpful and rewarding. Each investor will always look into the current market scenario before investing in any of the businesses. Similarly, they will also consider all the pros and cons before actually making a contract.
Here are the pros of an equity sharing agreement
- Less Burden – When the equity sharing agreement is prepared, it helps the shareholders and the company to manage their finances more efficiently, as it creates less burden on the company and the shareholders. It lessens the decision making burden and losses that occurred during the operations of the running the business. It also enables the shareholders and company to remain accountable for their actions.
- Credit issues gone – Credit problems are no longer an issue. If you lack creditworthiness due to low credit history or a lack of a financial track record, equity financing may be preferable to debt financing.
- Learn and gain from partners – You might develop informal collaborations with more qualified or experienced persons if you use equity financing. Some may be well-connected, allowing your company to profit from their expertise.
Here are the cons of an equity sharing agreement
- Sharing of Profit – Profits should be shared. Your investors will be expecting – and rightfully so – a cut of your earnings. However, it may be a reasonable trade-off if you benefit from their value as financial backers and their business skills and experience.
- Loss of Control – Control is being lost. It would be best to share control of the company in exchange for equity financing and all of its potential benefits.
- Possibility of Conflict – Conflict is a possibility. If there are differences in vision, management style, and ways of running the firm, sharing ownership and cooperating with others could cause some friction and even conflict.
How to implement an equity agreement?
To implement an Equity Agreement, it’s important to understand all the procedures and processes involved in the business. Investors can have various opinions on how they look at the implementation of the equity agreement. Before entering into the agreement, multiple amendments are put forward to avoid any further conflicts.
- Understanding the goals – It is crucial to understand the objectives of – this partnership agreement of equity sharing, and each shareholder must be aware of their rights and responsibilities. It should also be clear on the end goal of this investment.
- Vesting Schedules – The process of acquiring a full right that cannot be taken away by a third party is known as vesting. If a person completes their tenure according to the vesting schedule, they are entitled to all of the shares, and the corporation has no power to buy back or forfeit them if they decide to move.
- Funding Contributions – A contribution agreement is a legal document that spells out the terms and conditions of transferring an asset from one person to another. Small businesses also use these agreements to save aside money for retirement.
- Understanding the Sweat Equity – Sweat equity is a term that describes a person’s or a company’s commitment to a commercial endeavor or another initiative. Sweat equity is usually not monetary and takes the shape of physical labor, mental effort, and time.
- Splitting the Equity – When a company splits its shares, it simply exchanges new shares for old ones among all shareholders. Stock rollbacks, also known as share consolidations, are the polar opposite of stock splits, with one significant exception.
- Capital Infusions – In this section, the company considers what could be the possible call to action investments to be made in case of any loss or emergency, sometimes some shareholders don’t have capital investment. Instead of removing them from the share, the company keeps itself in a safe zone so it avoids any further problems for the company.
What does an equity agreement include?
Contracts are an inevitable element of owning a small business. It’s critical to keep track of your contracts and commercial contacts. The following are included while signing an equity agreement:
- Offer – The offer includes the details of the entire investment plan, whereas the names of the shareholders and what amount of investment they will be making in terms of assets. It also states the purpose, objectives, conditions, clauses. This offer can be either approved or disapproved by the party.
- Acceptance – Once the clauses and legalities are clear by all the shareholders, they can now form an acceptance letter containing all the information about equity sharing. After writing the acceptance letter, both can make a further move on to creating legal documents.
- Intention to create a legal relationship – There must be a purpose to create legal relations for a contract to be enforced, lawful and binding. The parties could not sue each other if they did not intend to do so. If there is no desire to create legal ties, the contract may become a simple promise.
- Consideration (money) – In contract law, consideration is an inducement to enter into a contract sufficient to enforce the courts’ commitment. In a contract for the sale of goods, the consideration for the vendor is the money paid, and the consideration for the buyer is the property sold.
How does the Equity Agreement work?
An equity contract is a sort of employment contract that allows employees to acquire a piece of the company’s ownership. Company owners frequently use equity agreements in addition to standard pay. Both the investor and the occupier contribute to the down payment; the occupier lives in the home, maintains it, and pays the monthly payments; and the parties split the home’s appreciation.
Example of using Equity Agreement
Let’s say someone wants to buy a house but can’t afford to do so independently. If a parent is willing to assist their child in purchasing a home, they can engage in a shared equity finance agreement. The two parties come to terms in the agreement that vary depending on the situation.
For example, the parents may decide to enter into an agreement in which they pay the down payment and sign a mortgage. This means they will be compelled to pay half of the mortgage until the loan is paid in full.
In this circumstance, the child pays half of the mortgage to the bank and the other half of the house’s market rate as rent to their parents. After splitting the costs of the mortgage and other housing costs, they would pay their parents an additional $500 if the home rents for $1,000 per month.
Equity Agreement Template
The Equity Sharing Association shall have the authority to contract for products and services as allowed by this Agreement, as well as undertake other duties on behalf of. An equity pooling agreement is drafted in such cases. This sample agreement grants two or more parties the right to own the property.
Manage Your Equity Agreement With Eqvista
Sometimes managing the total share of each equity shareholder is hard for companies. With Eqvista, be assured that each user has their own access and everything is embedded transparently. A user can upload, make changes, get better offers through the system, manage all their accounts, and verify it from us. Eqvista has made it easier to manage your equity. We also offer independent 409a valuations for finding your company value. Contact us to know more!