What should the representations and warranties in the note purchase agreement be?
Takeaway: Note purchase agreements typically have pretty light representations and warranties. They are usually limited to representing that the company is duly organized, has the authority to enter into the agreement, and won’t breach any other agreement by issuing the notes. There are sometimes a few more including representations around litigation or intellectual property.
When a startup raises funds through the sale of convertible promissory notes, it typically enters into a note purchase agreement with its investors. One of the critical components of this agreement is the representations and warranties section, which outlines specific assurances provided by the startup and, in some cases, the investor. In this post, we will explore the purpose of representations and warranties, the typical representations and warranties found in note purchase agreements for convertible promissory notes, and the implications for startups and investors.
The Purpose of Representations and Warranties
Representations and warranties serve as assurances provided by the parties to a note purchase agreement to confirm the accuracy of certain facts and the compliance with specific legal and regulatory requirements. They provide a basis for the parties to enter into the agreement and offer protection against potential risks and liabilities. In the context of convertible promissory notes, representations and warranties primarily concern the startup's operations, financial condition, and compliance with applicable laws and regulations.
Typical Representations and Warranties
While the specific representations and warranties in a note purchase agreement may vary depending on the negotiation between the startup and the investor, some common representations and warranties include:
Organization and Good Standing: The startup represents that it is duly organized, validly existing, and in good standing under the laws of its jurisdiction of incorporation.
Authority and Enforceability: The startup represents that it has the necessary corporate authority to enter into the note purchase agreement and that the agreement constitutes a legally binding obligation on the startup.
No Conflicts: The startup represents that entering into the note purchase agreement and issuing the convertible promissory notes will not violate any existing contracts, agreements, or legal obligations to which the startup is a party.
Compliance with Laws and Regulations: The startup represents that it is in compliance with all applicable laws, rules, and regulations governing its operations and that it has obtained all necessary permits, licenses, and consents required for its business.
Financial Statements: The startup represents that its financial statements are accurate, complete, and prepared in accordance with generally accepted accounting principles (GAAP).
Intellectual Property: The startup represents that it owns or has the necessary rights to use all intellectual property required for its business and that there are no claims or disputes related to its intellectual property.
Litigation: The startup represents that there are no pending or threatened lawsuits, claims, or disputes that could materially affect its business, financial condition, or ability to perform its obligations under the note purchase agreement.
Material Contracts: The startup represents that it has disclosed all material contracts and agreements to which it is a party, and that it is not in default or breach of any such contracts.
Implications for Startups and Investors
Properly drafted representations and warranties in a note purchase agreement play a crucial role in protecting the interests of both startups and investors:
For Startups: Making accurate and complete representations and warranties is essential to maintain credibility and trust with investors. Startups should carefully review the representations and warranties they make to ensure they can confidently stand by them and avoid potential legal issues or disputes.
For Investors: The representations and warranties provided by the startup serve as a basis for evaluating the investment opportunity and mitigating potential risks. Investors should carefully review these assurances and conduct due diligence to verify the accuracy of the information provided.
In a note purchase agreement, representations and warranties play a crucial role in ensuring that both startups and investors are protected and well-informed. They provide the foundation for a successful financing relationship by creating transparency and trust between the parties. When drafting and negotiating the representations and warranties in a note purchase agreement, both startups and investors should carefully consider the specific assurances provided and their potential implications.
It's important for startups to engage experienced legal counsel when preparing the representations and warranties in a note purchase agreement. This will ensure that they accurately reflect the startup's current situation and comply with applicable laws and regulations.
For investors, conducting thorough due diligence is essential to confirm the accuracy of the representations and warranties made by the startup. This process will not only provide greater confidence in the investment but also help identify any potential red flags or areas of concern that may warrant further negotiation or clarification.
Conclusion
Understanding and carefully drafting the representations and warranties in a note purchase agreement for convertible promissory notes is an essential component of a successful financing transaction. By ensuring that both parties are well-informed and protected, startups and investors can build a solid foundation for a fruitful and long-lasting relationship.