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Neuron

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A common feature of U.S. venture capital deals is the provision of an opinion of counsel regarding certain key matters before investors will close a financing round. These opinions are part of an investor’s due diligence process and provide added assurance as to elements of the transaction.
What are legal opinions?
Legal opinions are addressed to the investors in a venture or growth financing round and summarize the legal conclusions of counsel (usually the company’s counsel) concerning the elements of a particular transaction.
Legal opinions confirm various legal matters, typically including topics such as that a transaction complies with applicable laws and that the rights and obligations of the parties involved are enforceable. Oftentimes, these opinions mirror warranties provided by the company to investors already.
If the company is giving many of these as warranties already, why do investors ask for opinions?&nbsp; 
As a starting point, a company may often not be legally sophisticated enough to understand the warranties. As such, they will seek advice from their counsel if they can give the warranties. The opinion serves as a means of confirming that the company has actually considered the warranties and disclosures it is giving since it requires a third-party law firm to validate the statements.&nbsp;
The opinion also serves to leverage one of the most knowledgeable parties other than the company itself to help validate the key elements of the transaction. For example, while investor counsel can conduct a capitalization tie out as part of due diligence, it is often a new investor counsel each round. However, if company counsel remains consistent for each transaction, it can lever its existing knowledge and prior opinion work to bringdown the prior work performed rather than starting from scratch. This can bring significant cost savings to the parties and also lead to faster transactions.
Investors also view opinion practice as a valuable tool to reduce risk in evaluating the quality of the assets in which they invest.. As discussed in our preceding article regarding warranties, many investors care less about the legal recourse that warranties and disclosure provide since the target of a claim is often their own invested capital. Rather, many investors seek to perform sufficient diligence prior to investment to reduce the risk of value leakage on the front end. The legal opinion is a means of creating additional confidence in the warranties.&nbsp;
Wait, does the lawyer provide Warranty &amp; Indemnity (W&amp;I) insurance?
Not quite, but the added rigor of the opinion is valuable protection for investors. Unlike the company or the founder, the law firm typically is a much greater repeat player in an ecosystem. If a law firm has a reputation for shoddy advice and opinions that are proven wrong, investors will not accept those law firms’ opinions.
That reputational risk motivates law firms to carefully review the content of their opinions and the underlying facts in ways that founders and companies do not. A founder’s focus is building a business, and they may be sufficiently risk tolerant to gamble on shoddy disclosure to investors. However, a law firm’s business is in part driven by providing that level of assurance, and they expect their business will be materially harmed with a reputation for failed opinions.
Additionally, beyond the concern for reputational harm, law firms and the lawyers that comprise them are bound by various rules of professional responsibility. As a result, they could be liable for malpractice or sanctions by their governing authority/bar. In many jurisdictions such as most U.S. states, law firms and lawyers are not permitted to limit their liability for malpractice contractually with a client.
OK, so the lawyer is paying more attention now. What is the opinion?
The opinion typically includes a description of the transaction, a list of reviewed documents and matters, assumptions and qualifications, limitations as to the laws of the relevant jurisdiction of interpretation and who may rely on the letter, and, of course, the actual opinions themselves. The legal opinions typically include the following in most U.S. venture deals:
<ul>
<li>Due Incorporation and Good Standing:&nbsp;Is the company legally incorporated and in good standing?</li>
<li>Corporate Power: Does the company possess the necessary corporate powers to enter into the transaction?</li>
<li>Capitalization:&nbsp;What is the company’s capital structure, including what is authorized, issued, and outstanding?</li>
<li>Valid Issuance:&nbsp;Are the shares issued in the transaction duly authorized and validly issued?</li>
<li>All Necessary Corporate Action:&nbsp;Have all required corporate actions been taken to authorize the transaction?</li>
<li>Enforceability:&nbsp;Are the transaction documents legally enforceable?</li>
<li>No Conflicts with Laws or Material Agreements:&nbsp;Does the transaction violate applicable laws or significant agreements?</li>
<li>No Government Consents:&nbsp;Are governmental or regulatory consents required to consummate the transaction?</li>
<li>Securities Law Exemption:&nbsp;Do the securities issued in a transaction qualify for an exemption from U.S. securities registration requirements?</li>
<li>No Litigation:&nbsp;Is there any pending litigation that could adversely affect the transaction?</li>
</ul>
How does the lawyer check all that stuff?
To be able to deliver an opinion, counsel must conduct a rigorous due diligence process and may require supporting documentation from the company. Counsel will also typically ask for a certificate from one of the company’s officers.
For example, one of the most complicated issues that often arise when drafting a legal opinion is a company’s capitalization. Many clients often believe that they will encounter no issues with their share capital. However, it is frequently uncovered in due diligence that significant problems do indeed exist.
At a practical level, identifying the need for a legal opinion should occur as early as possible in the transaction process, ideally at the term sheet stage, to ensure adequate preparation time.
That sounds like you are just trying to charge me more money for diligence the investor is doing anyhow?
The issuing company will end up spending more on diligence than they would if there was no opinion, but the opinion often brings costs down overall. First, it allows the company to negotiate for a lower investor fee reimbursement on the front end if they can promise an opinion. The investor knows they have less work to do and will rely on it. Second, the company counsel is a repeat player in each round typically, so they will largely roll forward from the prior opinion so the additional work is often less onerous than for an investor counsel that has no prior involvement with the company. Third, it reduces the risk of embarrassing disclosures and overblowing an issue. If an investor finds an issue without the company finding it, they tend to start flyspecking more and more, which results in more costs in the diligence process. The opinion process helps preempt the ugly disclosure but allowing company counsel to stay ahead of the issues.
So what is normal?
It depends on the jurisdiction in which the deal is taking place, and who are the parties. In UK-governed deals, legal opinions are generally not standard in venture capital financings. It is considered off-market to request or provide a legal opinion in such transactions. Instead, investors typically rely on their own due diligence efforts to assess the risks associated with a given transaction. This tends to be a function of the historical relationship with company counsel that is more stage specific. Early-stage counsels advise early-stage companies, late-stage counsels advise late-stage private companies and then Magic Circle firms historically advise public companies.&nbsp;
The incremental benefit of obtaining a UK legal opinion in matters such as capitalization may be perceived as minimal (certainly when compared with the additional upfront cost) since there is little continuity of law firms resulting in a more transactional approach. However, the result of this is that it is quite rare for there to be no issues with UK venture-backed share capitalization upon exit. Those issues often drag out deal timelines, increase the risk profile on exits for the sellers and can, on occasion, go to value or even kill the deal.
By contrast, legal opinions are a common feature in U.S.-governed deals, especially in the context of venture financing transactions. In the U.S., the largest venture-stage law firms remain with their clients through their entire lifecycle, many times even taking them public. The opinion at a venture stage often serves as a means of better preparing the company for an exit event later. Thus, the value of the relationship is much greater and more efficient. Furthermore, U.S. investors largely expect opinions much more regularly as a matter of course.&nbsp;
While there is no right or wrong answer on this, we would expect as the UK venture market moves closer in nature to the U.S. style of multiple venture rounds followed by a trade sale or IPO, opinion practice will become increasingly interesting to UK companies as a means of attracting better capital and preparing for exit.
For more information on transatlantic legal opinion practice in venture capital, please contact Wilson Sonsini attorneys <a href="https://www.wsgr.com/en/people/michael-c-labriola.html">Michael Labriola</a> or <a href="https://www.wsgr.com/en/people/richard-goold.html">Richard Goold</a>.

“Trust Me, It’s Good…” Transatlantic Legal Opinion Practice in Venture Capital

Client Advisories

Determining “certainty of asset” is a key element of any investment. When an investor takes a minority position as it does in a typical venture or growth capital investment, the approach to ascertaining certainty differs based on the risk appetite and the alignment of the investor and the portfolio company. This article explores and compares the typical U.S. and UK approaches to warranties and disclosures in venture/growth financing transactions.
Warranties are assurances provided by a company to the investors intended to confirm the accuracy of certain statements and conditions about the company’s state of affairs. Both the U.S. National Venture Capital Association (NVCA) model stock purchase agreement and the UK’s British Private Equity &amp; Venture Capital Association (BVCA) subscription agreement include a series of model warranties relating to the issuing company and its business. A key difference between the U.S. and the UK is the approach to warranties.<a name="_ftnref1" href="#_ftn1">1</a>
1. U.S. vs. UK Approach to Warranties
In general, warranties help mitigate risks for investors by giving them a greater insight into the operations and integrity of the underlying business and the bundles of contracts that constitute the company. Depending on the size of the transaction and sophistication of the investors and company, the warranties may serve as the key element of an investor’s diligence, as they typically cover the essential elements of the company’s operations that would determine whether or not an investor would want to invest in such company. These warranties serve two functions: 1) force disclosure of information and 2) set boundaries around what the parties agree is the state of the company at the time of the investment that also influence recovery of damages if proven wrong. Warranties tend to ask questions of the “average” company so that they are generally not heavily customized. A warranty is sort of like ordering a Big Mac®or Royale with Cheese; the investor is buying something standardized.
However, if there is no available ketchup and mustard for that order, the store needs to tell you what is missing since you expect it. You can then decide to buy it still (or ask for a discount). Disclosures are the equivalent of the cashier telling you they are all out of ketchup and mustard but otherwise have a Big Mac®for you. Disclosures modify warranties to give a more specific understanding of the asset. Any matter that is disclosed serves to modify the warranty accordingly such that the combination of information makes it true as of the point of measurement.
2. NVCA
The NVCA model stock purchase agreement includes a robust set of warranties expected in venture financing agreements. The NVCA’s approach emphasizes comprehensive coverage of all critical areas that might affect the company’s valuation and operational integrity.
Most critically, the NVCA model is built around the concept of successive rounds of investment building to a sale or IPO of the business. As such, the warranties tend to be closer to a full set of trade sale warranties in many respects as it helps the company prepare each round of financing for an exit event. Additionally, the NVCA model is built around disclosure exceptions (i.e., the warranties are true EXCEPT as disclosed in specific details) where the issuing company has the greatest ability to manage the disclosure efficiently. The U.S. market is focused on rapidly educating investors. The principal goal is to provide investors with a complete and accurate picture of the company’s status, ensuring informed decision-making at the time of investment rather than as a tool to settle damages later.
Notably, the NVCA model forms are essentially silent on procedures for breaches of warranties except to normally include a time limit for claims for breaches of warranties, unlike the BVCA model forms. While the U.S. is known for being a more litigious country than the UK, this is often a curious difference between U.S. and UK practice. However, this is largely due to the sheer volume of deals and repeat players in the U.S. As a general matter, U.S. investors do not view the warranties as a practical means of recourse short of a fraud claim since the reputational effect of an investor suing a portfolio company for breach of contract can be quite damaging to new deal flow for the investor. Additionally, most U.S. companies are built for high growth, high cash burn strategies, so the available assets for recourse in most cases would be the cash contributed by the same investors anyhow. As such, the NVCA forms typically omit mechanics around claims against the warranties as not worth spending lawyer time on the negotiation relative to the benefits.
Finally, U.S. investors generally eschew founder warranties as not meaningful and off-market. This is again largely a function of deal volume and more historical repeat play in the U.S. The investors may be investing in a serial entrepreneur with whom they trust to build the business because they have seen the entrepreneur build previous businesses. Additionally, most U.S. investors do not practically expect the value of any real or perceived recourse on the founder warranties outweighs the relationship harm of the pressure it is perceived to put on the founders.
3. BVCA
As the name of the organization—the British Private Equity &amp; Venture Capital Association—suggests, the approach taken by the BVCA originally evolved from that used in private equity deals. The warranties seen in the BVCA model documents are significantly broader in scope but far less specific than the warranties provided by the NVCA model documents. Similar to a trade sale, the BVCA model also requires extensive disclosures, often via detailed schedules that are not meant solely to address exceptions to warranties. As a private equity environment typically has one investor taking a significant or controlling stake in a company, the underlying structure of the BVCA warranties was not originally intended for multiple rounds as a company grows and bringing in multiple future investors. The BVCA approach to warranties is much broader but also less likely to prompt the issuer to actually make specific disclosures. Thus, the investor expects to bear the burden of figuring out what is missing, and they are often expecting to be in position to seek recourse from a company far more readily.
With respect to recourse, BVCA documents typically incorporate certain negotiated limitations on liability in respect of the warranties. While similar to the NVCA in that they both often include a time limit for claims, the BVCA has a more fulsome set of procedures similar to a trade sale for claims including limitations on who can make a claim among investors, overall liability caps (usually exempting fraud), and often “baskets” for claim sizes. Unlike a trade sale, it is not atypical for the total cap on liability to be equal to the total investment amount.
In addition, UK and European investors have historically sought to require the founders to provide the same warranties, therefore exposing them to direct liability for contractual breach beyond a fraud claim. However, it is typical in those cases for each such founder’s liability to be capped at a salary multiple of 1-2x the founder’s gross salary (absent fraud). In recent years however, the UK venture/growth investor community has increasingly given up on using founder warranties as evidenced also by the recent removal of the term in the BVCA model documents.
Disclosure under the BVCA is generally broader and less focused than under the NVCA. In the UK, a company will prepare a separate disclosure letter, which will contain both general disclosures (i.e., matters deemed to be within an investor’s knowledge, such as information available as part of the company’s public record at the UK’s Companies House) and specific disclosures that modify warranties. As the market has globalized and moved closer towards standard venture capital and away from private equity, the disclosure exercise became more akin to that under NVCA documents, with targeted disclosures against the warranties. The warranties, however, remain much broader than that of their U.S. counterparts.
4. Worlds Colliding?
In either jurisdiction, it is reasonably rare for reputable investors to bring a claim on warranties except in situations that rise to the level of fraud. This is due to the fact that investors would be bringing claims against the money they put in anyhow, so there is little upside value in a claim except perhaps a basis to claim a bigger percentage of the company. However, that usually comes at the expense of the relationship with the founders, who are often critical to the business. Claims tend to be used only in extreme situations where founders or management are engaged in true bad behavior, as most investors are loath to gain a reputation as being hostile to founders.
Practically, the U.S. model is very battle-tested for the venture capital model: raise successive rounds, get strong information from the best source (the issuer) and set the company (and the investors) up for exit. The UK model is increasingly moving this direction as the more venture-capital style of deals promulgate in Europe as compared to the historical private equity approaches. It seems unlikely these changes will happen overnight, but over time we expect increased convergence of the content of warranties, and approaches on liability and disclosure.
For more information on warranties and disclosures in the UK and U.S., please contact Wilson Sonsini attorneys <a href="https://www.wsgr.com/en/people/michael-c-labriola.html">Michael Labriola</a> or <a href="https://www.wsgr.com/en/people/stacy-kim.html">Stacy Kim</a>.
<hr>
<a name="_ftn1" href="#_ftnref1">[1]</a> One important but subtle point to highlight is the name of these provisions. In this article, we refer to warranties to mean both “representations and warranties” in U.S. parlance. U.S. law generally considers representations to be statements of fact (e.g., a company owns a particular asset), and warranties are promises about a state of an asset or condition (e.g., an asset is warranted to be in operable condition for the use as intended). There is not an appreciable difference under U.S. law as to the difference in a breach of either. By contrast, many venture practitioners in the UK consider a meaningfully different view of representations. Under UK law, representations are legally factual statements that are used induce a party to enter into a contract. Thus, if a representation is not true, then the underlying inducement is invalid, and the aggrieved party may be permitted to void the contract and/or rescind the payment and share issuance. As a result, UK venture practitioners tend not to use the term representations where possible to avoid a presumption of a more substantial remedy notwithstanding that many statements will end up being de jure representation even if not expressly named as such.

“You Promised What?!” Warranties and Disclosure in the UK and the U.S.

On September 10, 2024, Neurode announced that it has raised $3.5 million in pre-Seed funding and is launching its private beta which users can join now at <a href="https://www.neurodelabs.com/">neurodelabs.com</a>.
The Sydney, Australia-based company is pioneering a wearable headband to track and treat ADHD symptoms using light electrical stimulation in the prefrontal cortex. The headband is currently available through a private beta and Neurode plans to seek FDA approval for the device in the future. The pre-Seed funding round was led by Khosla Ventures, with participation from PsyMed Ventures. Neurode, which filed patents for its device in 2021, has used the funding to support clinical trials.
Wilson Sonsini Goodrich &amp; Rosati represented Neurode in the transaction. The Wilson Sonsini team includes <a class="rubycontent-page-link rubycontent-page-1281" title="Lang Liu" href="https://www.wsgr.com/en/people/lang-liu.html" data-rubyapp-plugin="rubycontentpagepicker" data-rubyapp-reference="content::1281">Lang Liu</a>&nbsp;and <a class="rubycontent-page-link rubycontent-page-220351" title="Will Andrews" href="https://www.wsgr.com/en/people/will-andrews.html" data-rubyapp-plugin="rubycontentpagepicker" data-rubyapp-reference="content::220351">Will Andrews</a>.
For more information, please see news coverage by&nbsp;<a href="https://url.us.m.mimecastprotect.com/s/KfXAClY8VwuRoGVLTGfoCz5fYE?domain=techcrunch.com/">TechCrunch</a>.

Wilson Sonsini Advises Neurode on Pre-Seed Financing

Client Highlights

On September 18, 2024, in a Wall Street Journal exclusive, Pie, a mobile events app, revealed that it has raised $11.5 million in a Series A financing round, led by Forerunner Ventures and included participation from Ev Williams (a co-founder of Twitter and founder of Medium), Origin Ventures, and Renegade Partners, as well as longtime investor Precursor Ventures. The company has raised $24 million to date.
Launched in 2020, the Pie app allows users to plan their own events, with tools such as polls to agree on a convenient date, and&nbsp; emphasizes meeting new people in a group setting. An AI agent on the app, based on the OpenAI enterprise stack, helps personalize events as well. Pie reports 20,000 monthly active users and is growing 40 percent month over month, according to Pie founder Andy Dunn, who is also co-founder of menswear brand Bonobos.
Wilson Sonsini Goodrich &amp; Rosati represented Pie in the financing. The Wilson Sonsini team included <a href="https://www.wsgr.com/en/people/megan-j-baier.html">Megan Baier</a>, <a href="https://www.wsgr.com/en/people/angela-loc.html">Angela Loc</a>, and <a href="https://www.wsgr.com/en/people/brian-ginsberg.html">Brian Ginsberg</a>.
For more information, please see the Wall Street Journal <a href="https://www.wsj.com/articles/bonobos-co-founder-andy-dunns-new-startup-aims-to-defeat-social-isolation-d90460e4">article</a> (may require subscription), as well as Pie founder Andy Dunn's LinkedIn <a href="https://www.linkedin.com/posts/andyrdunn_exclusive-bonobos-co-founder-andy-dunn-activity-7242164170568146945-6wpE/">announcement</a>.

Wilson Sonsini Advises Pie on $11.5 Million Series A

On September 19, 2024, Gamebeast, a tooling platform in the user-generated content (UGC) video game industry "unlocking maximum growth potential" for Roblox developers, has announced a pre-Seed raise of $3.7 million. The raise was led by J2 Ventures, a $250-million deep-tech venture capital firm based in Boston, with significant participation from incubating investor a16z SPEEDRUN, The Mini Fund, and Le Zhang, CEO of Spaceport. Gamebeast is the first no-code platform designed for Roblox developers, but its solutions are also useful in other digital optimization environments, such as defense applications. The funding will be used to launch on new platforms, leverage AI-driven analytics, build a leading data insights and reporting platform in the user-generated content space, and enhance Gamebeast's internal insights platform for strategic game and data acquisitions simultaneously with the work it will launch with the U.S. Military.
Wilson Sonsini Goodrich &amp; Rosati represented Gamebeast in the transaction. The Wilson Sonsini team was led by <a href="https://www.wsgr.com/en/people/mark-b-baudler.html">Mark Baudler</a>, <a href="https://www.wsgr.com/en/people/jonathan-chan.html">Jonathan Chan</a>, <a href="https://www.wsgr.com/en/people/peter-bratton.html">Peter Bratton</a>, and <a href="https://www.wsgr.com/en/people/james-power.html">James Power</a>.
For more information, please see Gamebeast's <a href="https://www.gamebeast.gg/news/gamebeast-secures-3-7-million-in-pre-seed-funding">press release</a>. Further coverage can be found at <a href="https://techcrunch.com/2024/09/18/the-22-year-old-building-roblox-developer-tools-to-make-gaming-more-efficient/">TechCrunch</a> and <a href="https://venturebeat.com/games/gamebeast-raises-3-7m-in-funding-for-roblox-games-support/">VentureBeat</a>.

Wilson Sonsini Advises Gamebeast on $3.7 Million Fundraise

On September 19, 2024, GC Therapeutics (GCTx), a biopharmaceutical company created to scale and unlock the next generation of cell therapy-based medicines, launched and announced the successful completion of a $65 million Series A financing led by Cormorant Asset Management with participation from Mubadala Capital, Andreessen Horowitz (a16z) Bio + Health, Medical Excellence Capital, Cercano Management, and Pear VC, bringing the total capital raised by GCTx to $75 million. Wilson Sonsini Goodrich &amp; Rosati advised GC Therapeutics on the transaction.
GCTx’s proprietary induced pluripotent stem cell (iPSC) programming platform, TFome™ (Transcription-Factor-ome, pronounced as tee-eff-ome), integrates the latest advancements in synthetic biology, gene editing, cell engineering, and machine learning to improve patient access and overcome the development and scaling challenges of cell therapy. The platform could produce off-the-shelf cell therapies up to 100 times more quickly than conventional methods.
The Wilson Sonsini team that advised GCTx on the transaction includes <a href="https://www.wsgr.com/en/people/mark-r-fitzgerald.html">Mark Fitzgerald</a>, <a href="https://www.wsgr.com/en/people/leah-hengemuhle.html">Leah Hengemuhle</a>, and <a href="https://www.wsgr.com/en/people/aaron-b-gordon.html">Aaron Gordon</a>.
For more information, please see GCTx's <a href="https://www.gc-tx.com/newsandpress/gc-therapeutics-launches-to-scale-and-unlock-the-next-generation-of-cell-therapynbsp">news release</a>. Additional coverage can be found on <a href="https://www.fiercebiotech.com/biotech/science-fiction-reality-new-george-church-founded-biotech-raises-75m-cell-therapy-platform">FierceBiotech</a>, <a href="https://cen.acs.org/business/start-ups/George-Church-launches-stem-cell/102/web/2024/09">Chemical &amp; Engineering News</a>, and <a href="https://www.biopharmadive.com/news/gc-therapeutics-launch-george-church-stem-cells-transcription-factors/727465/">BioPharma Dive</a>.

Wilson Sonsini Advises GC Therapeutics on $65 Million Series A

On September 17, 2024, GreenLite, a construction technology company making permitting faster and more predictable for builders, developers, and municipalities, announced the successful completion of its $28.5 million Series A financing less than a year after its launch. The round was led by Craft Ventures with participation from 53 Stations, Trust Ventures, and LiveOak Ventures. Wilson Sonsini Goodrich and Rosati advised GreenLite on the transaction.
GreenLite helps builders, developers and municipalities to streamline the permitting process through its Private Plan Review platform, enabling them to work with one regulatory agency and significantly reduce development timelines. The additional capital will be used to improve GreenLite's technology platform and private plan review offering, while enabling the firm to expand into new markets and increase its collaboration with local government agencies.
The Wilson Sonsini team that advised GreenLite on the transaction includes <a href="https://www.wsgr.com/en/people/brian-dillavou.html">Brian Dillavou</a> and <a href="https://www.wsgr.com/en/people/melanie-froh-carver.html">Melanie Froh Carver</a>.
For more information, please see GreenLite's <a href="https://www.prnewswire.com/news-releases/greenlite-raises-28-5m-to-privatize-permitting-for-developers-and-regulatory-authorities-302250308.html">news release</a> or Craft Ventures' <a href="https://medium.com/craft-ventures/why-we-invested-in-greenlite-121729e636e0">blog post</a>. Additional coverage can be found on <a href="https://techcrunch.com/2024/09/17/greenlite-founded-by-an-ex-gopuff-exec-automates-construction-permitting/">TechCrunch</a>.

Wilson Sonsini Advises GreenLite on $28.5 Million Series A

As U.S.-based venture capital funds have become an increasingly significant source of capital for UK start-up and scale-up companies, the negotiation of terms often give rise to gaps in expectations and market norms between the two jurisdictions. &nbsp;
Many of the differences are often a function of the investment styles in the respective markets. Generally speaking, U.S. venture and growth investors tend to invest with a more aggressive high risk/high return approach, whereas UK-based funds often take a more targeted approach with less potential for upside but similarly less risk of downside. While neither approach is right or wrong, it is important for the parties to enter into any deal with full awareness as to the differences in expectations among investors. Without alignment, founders, management, and investors often find themselves at odds soon after investment leading to painful changes that often limit value for all parties or even complete failure of the business and loss of investment.
In addition, while the U.S. and UK share a common legal tradition, there are systemic differences in deal structure as well driven by both differences between various elements, both substantive and structural, of UK and U.S. law and regulatory processes.
While there still remain more similarities than differences in the style of deals in both jurisdictions, this article highlights the top differences in structure, process and terms between a U.S. and UK-style venture/growth capital deal.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1. Typical Transaction Documents and Timing
The most obvious difference between UK and U.S. VC financings is the structure of the transaction documents. A U.S. deal appears to have more documents than a UK deal, which will frequently confuse each party. The U.S. investor will think the UK documents are not fulsome enough, while the UK investor will be concerned that the parties are spending too much detail on the documents.
First, it is helpful to explore some history. The U.S. uses a widely accepted sets of model documents as a framework for transactions. The U.S.-based National Venture Capital Association (NVCA) model documents are used in 80 percent-plus of venture financings as a baseline. That is not to say that NVCA-styled deals are not negotiated, but the NVCA forms have been in use for decades and are updated annually with input from a number of market sources, so the exercise is much less custom-built. Additionally, the U.S. forms were designed from inception for the venture capital lifecycle: modular to allow raising multiple rounds of capital and designed to facilitate a sale or IPO. By contrast, the UK has a younger corollary to the NVCA: the British Venture Capital Association’s (BVCA) model documents. Historically, the BVCA model forms were based on private equity-styled documents that were less functional for layering in multiple rounds of financing and emphasized control by certain named parties. As a result, until recent modifications to the BVCA forms, they were less widely adopted in practice as compared to their American counterparts. However, with changes in recent years, they are increasingly aligning with principles in the NVCA models to make them more user-friendly and an increasingly preferred starting point for drafting.
Second, in terms of difference in structure, the NVCA includes five main transaction documents, whereas the BVCA only has three main transaction documents. Overall, however, the suite of rights is fairly similar except as further explored herein. The difference in document sequencing is largely driven by three major factors: i) the public availability of documents, ii) enforceability considerations under Delaware law, and iii) U.S. IPO disclosure requirements. In the U.S., the only governing document for venture-stage companies that can be accessed publicly in most cases is the company’s Certificate of Incorporation; there is no public stock ledger or list of directors or shareholder resolutions. As a result, the parties treat the certificate of incorporation, which is generally the most superior document, as written for all holders of the securities, and then layer in specific rights into the supporting documents. In addition, the Right of First Refusal and Co-Sale Agreement and Voting Agreement are designed to fall away upon an IPO and thus never need to be filed publicly in a public offering.
Third, in terms of deal efficiency, despite having more pages, the NVCA forms tend to be a more well-trodden path for parties and are built for greater speed to execute and fewer points of drafting failure. By contrast, the BVCA forms have only recently become more streamlined and also tend to include more detail to populate. As a result, the average NVCA-styled deal will tend to move from term sheet to completion faster than a BVCA-styled deal largely due to efficiency of the form.
Fourth, the litigation environment of the jurisdiction will inform the level of detail. The U.S. generally does not have the “loser pays” rule common in the UK and many other countries; in many non-U.S. countries, the loser in litigation bears a significant part of the winner’s legal fees. While the NVCA has an optional provision for the parties to agree that loser pays, the more typical environment in the U.S. is that even a relatively weak claim in the U.S. has value because the party bringing the claim knows the defendant’s cost to settle the claim likely is less than the cost of defending it. Thus, U.S. investors tend to seek greater clarity in the documents on the front end, making them more detailed than a non-U.S. deal, with an eye towards avoiding a potential for dispute completely since the prospect of a dispute may be higher.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;2. The Effects of Tax Considerations for Early-Stage Investors 
In the UK, certain qualifying investors can gain preferential tax treatment on income and capital gains relating to an investment through the UK’s Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) depending on the type of shares purchased by the investor and duration of holding in qualifying companies. Venture capital trusts (VCTs) also offer investment vehicles that give individuals income tax relief on VCT investments.
SEIS/EIS investment plays an important role in the UK pre-seed (and seed) VC tech ecosystem, and to qualify for tax relief, in addition to the Company meeting certain substantive criteria, the SEIS/EIS/VCT shares must be equivalent to full risk ordinary shares (i.e., they cannot be redeemable or carry any special or preferential rights save for limited preferential rights to dividends). Additionally, the liquidation preference language will be bifurcated for situations where SEIS/EIS/VCT shares can gain a preference and where it cannot by law. The result of these structural risk limitations is the SEIS/EIS/VCT shares look and are meaningfully different when compared to more classic venture/growth capital investment terms. In early-stage UK financings, it is not unusual for SEIS/EIS/VCT shares to be issued without dividend or full liquidation preferences and/or anti-dilution protection. &nbsp;
In the U.S., U.S. taxpaying investors can take advantage of a similar investors purchasing qualified small business stock, or QSBS, in a financing to exclude a certain amount of the gains on a sale of such stock made at least five years after the initial purchase if the entity is a U.S.-organized corporation. Unlike SEIS/EIS/VCT, the requirements for QSBS generally relate to the stage and nature of the underlying business and not to the investment features of the shares purchased except with respect to later buybacks by the Company. As a result, outside of a few sentences in the documents that express the desire of the investors to qualify for QSBS treatment, there is little difference in the substance or look of QSBS-eligible shares.
As a result, there is structural tension between some UK and U.S. investors around this issue. SEIS/EIS/VCT investors often insist that if they cannot have anti-dilution or liquidation preferences, no investor should get it. By contrast, U.S. investors in UK companies cannot avail themselves of SEIS/EIS/VCT or QSBS tax breaks, and they expect to have the typical protections they are used to having. Most deals result in having parallel series of shares that may be SEIS/EIS/VCT-eligible but lack the same preferences and protections as the other investors as a compromise, but this can be a major flash point between parties. UK SEIS/EIS/VCT investors feel aggrieved because they are taking lesser rights, while U.S. investors are not getting the same tax benefits and expect to get the full suite of investor protections as a result.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;3. Warranties and Recourse
Both the NVCA Stock Purchase Agreement and BVCA Subscription Agreement include a series of warranties (or statements of fact) relating to the issuing company and its business. While the NVCA warranties tend to be much more detailed and specific than the BVCA set, the NVCA is largely silent on procedures for breaches of warranties (except a time limit for claims). In addition, U.S. investors generally eschew founder warranties as not meaningful and off market. A later article in this series will dive deeper into the warranty practices in the U.S. and UK and how they shape an underlying deal.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;4. Diligence and Disclosure
In the UK, the company will generally prepare a separate disclosure letter, which will contain both general and specific disclosures that modify warranties. While typical U.S.-styled venture deals include specific disclosures it is not customary to permit general disclosures. As a result, U.S. investors often resist general disclosures in UK disclosure letters and typically expect more extensive warranties. Stay tuned for a future article in this series, which will provide more context on the similarities and differences between disclosure standards.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;5. Founder Vesting and Leaver Provisions
The management team is typically the key component of an early-stage company’s business value. As a result, investors in both U.S. and UK companies use contractual provisions to incentivize founders and key executives to remain with the company after the financing beyond merely the opportunity for appreciation of their shares. An upcoming article in this series will provide a more detailed discussion of the differences between the NVCA-style vesting schedules and the BVCA-style vesting and leaver provisions that each jurisdiction typically uses to provide those incentives.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;6. Employment, Non-Competition and Non-Solicitation Provisions
In the UK, investors often seek to protect their investment by including restrictive covenants on founders and key executives in both the Shareholders’ Agreement and in separate service agreements. These include engaging in completion or soliciting employees or customers. Many UK employees also have statutory protection over termination service and guaranteed notice periods such that they are not easily terminated. As such, there is a certain degree of balance between the position of the founder, who is entitled to some protection before termination, and the position of the company, who will seek non-competition protection.
By contrast, restrictive covenants are less commonly requested by U.S. investors due to issues surrounding enforceability which vary by U.S. state. However, major tech centers including California and Massachusetts generally prohibit non-competition provisions except directly in connection with a sale of a business. In many jurisdictions, not only are the provisions unenforceable, but they may result in penalties against employers. Accordingly, U.S. investments nearly universally do not include non-competition provisions. However, founders also bear greater risk of termination under U.S. employment law, which generally favors at-will employment arrangements with no statutory notice and severance periods in most cases. We explore these restrictions and their enforceability on both sides of the Atlantic in greater depth in an upcoming article in this series.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;7. Investor Protective Provisions (a.k.a., “Veto Rights”)
Both the BVCA and the NVCA model documents typically include minority investor consent rights over certain key shareholder decisions involving the company. While the NVCA tends to limit these rights to shorter list of fundamental matters that go to the heart of the investment (e.g., liquidation of the company, exit decisions, issuing shares pari passu or senior to the preferred class and transactions or arrangements involving founders, among others), the BVCA list of investor veto matters is far more extensive and includes operational matters as well. In addition, where an investor or group of investors has a right to appoint a director to the board, a BVCA deal will also typically include a list of investor director veto rights over certain board decisions. By contrast, although the NVCA model form includes a more limited list of investor director veto matters as an optional provision, they are less commonly included in U.S. deal documents.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;8. Anti-Dilution Provisions
Both U.S.- and UK-styled deals often include anti-dilution rights that provide enhanced economic protection for investors from the full dilutive effect of a down-round, which are typically based on a broad-based weighted average mechanism. As noted earlier, a fundamental difference on inclusion of these provisions is influenced by SEIS/EIS/VCT status of UK investors, who cannot avail themselves of such protection.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;9. Share Issuances and Transfers
The NVCA and BVCA model documents both include restrictions on the transfer of shares of the company. These restrictions come in the form of pro rata rights (referred to in the UK as preemptive rights) on new share issuances and rights of first refusal over transfers.
UK company law requires new issuances of shares for cash to first be offered on a pro rata basis to existing shareholders. Such rights can be disapplied by a 75 percent majority of voting shareholders either generally or in respect of specific issuances. Modified preemption rights on new issuances are typically included in BVCA financing articles of association and are often made more broadly available to shareholders. By contrast, the most U.S. jurisdictions do not have mandatory preemption rights. However, the NVCA financing documents typically include contractual pro rata rights in respect of new issuances of shares, although this is often limited to large “major” investors and not to all stockholders. &nbsp;
Both the NVCA and BVCA model documents grant a contractual right of first refusal to investors (typically restricted to major investors in the U.S.) over transfers by founders and certain other ordinary/common shareholders. In addition to these rights, U.S. and UK deals usually include investor co-sale participation rights, minority tag-along and majority drag-along rights (typically exercisable in each case on a change of control or exit sale) on broadly similar terms.
The most fundamental difference however between the U.S. and the UK is who is restricted on transfers. In UK deals, it is much more typical for all shareholders to be subject to restrictions on transfer while the company is private. By contrast, U.S. venture investors are generally never subject to restrictions on transfer, although they expect the common stockholders (including the founders) to be limited. This is likely due to certain structural differences in U.S. securities laws regarding resales but also the nature of the U.S. venture community, which has a much greater volume of repeat players that rely on the reputational effect of dissuading transfers before all parties exit.
&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;10. Registration Rights
U.S. investors typically expect to include provisions relating to registration rights, which allow them to compel the company to register its shares with the SEC at a later date to facilitate a resale when the company has gone public. These are generally of limited concern to companies and largely serve to protect larger investors from being treated differently from smaller stockholders that can sell without restriction in a public market.
In UK financings, registration rights are rarely requested as the UK securities laws do not impose the same restrictions on larger shareholders. However, the BVCA model documents in recent years have included registration rights in less detail along with an optional form registration rights agreement to help accommodate U.S. investors.&nbsp;
One other key difference outside the term sheets is also how quickly parties “lawyer up” in each jurisdiction. U.S. parties tend to involve their counsel earlier in the process, often at a term sheet stage. By contrast, UK investors do not tend to engage counsel quite as early for cost concerns. However, UK founders are often at a disadvantage if they do not lever experienced counsel at the term sheet stage. The most valuable bargaining chip a company has in a process if the competitive tension it can create among investors, but that bargaining power can be lost if the company signs an incomplete or one-sided term sheet that also results in weeks of exclusivity for an investor. Accordingly, in addition to appreciating the major differences in terms, we would also urge founders to plan ahead at the term sheet stage on all these issues.
For more information on the major differences in venture capital practices in the UK and the U.S., please contact Wilson Sonsini attorneys <a href="https://www.wsgr.com/en/people/michael-c-labriola.html">Michael Labriola</a>, <a href="https://www.wsgr.com/en/people/diviya-padman.html">Diviya Padman</a>, and <a href="https://www.wsgr.com/en/people/conor-cannon.html">Conor Cannon</a>.

“Would You Please Repeat That in English?” Unpacking the Major Differences in Venture Capital Practices in the UK and the U.S.

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