What is an Investment Contract? The Necessity of Contract Conclusion for Companies

When venture companies receive investments, they may receive funds from acquaintances or so-called angel investors, or they may receive investments from venture capital firms (VCs). In the case of receiving investments from acquaintances, there may be instances where an investment contract is not concluded due to pre-existing personal relationships.
On the other hand, in the case of investments from VCs, you will likely be asked to sign an investment contract. While you may hear about investment contracts when receiving investments, there may be aspects that are not fully understood, such as what an investment contract entails, why it is important, and whether there is a need to conclude one. Therefore, this article will explain the importance and necessity of concluding an investment contract.

What is an Investment Contract?

In business operations, various parties such as companies, management teams, investors, shareholders, and business partners are involved. An investment contract is a necessary agreement that adjusts the interests of the company, its management team, and investors, and is designed to prevent future disputes.

The content of an investment contract mainly includes the following:

• Content about basic matters related to investment
• Content about the preconditions for investment
• Content about shares and company management
• Content about withdrawal of investment
• Content about general clauses

Basic Information Regarding Investments

Generally, shares are issued to investors. In other words, the basic matter regarding investments involves investors paying money to a company, and in return, the company issues shares to the investors.

Therefore, the basic information about investments includes provisions about the type of shares to be issued, the number of shares to be issued, the price of the shares (stock price), and the total amount of money that the investor will pay.

Content Regarding the Preconditions for Investment

Investors make investments while bearing the risk that they may potentially incur losses. While it is challenging to completely eliminate this risk, it can be reduced if appropriate information about the company is obtained. Therefore, clauses regarding the preconditions for investors to make investment decisions are often stipulated.

For example, a company may stipulate a Representations and Warranties clause, which assures and guarantees the accuracy of the financial statements disclosed to the investor, such as the Balance Sheet (B/S), Profit and Loss Statement (P/L), Cash Flow Statement (C/F), and Statement of Changes in Shareholders’ Equity (S/S).

Related article: What are the Representations and Warranties in an Investment Contract?[ja]

Furthermore, clauses can be stipulated that confirm no subsequent events have occurred after the company disclosed information to the investor, and that the company will submit important documents such as minutes of the shareholders’ meeting to the investor, which are preconditions for the investor to make an investment decision.

Details Regarding Shares

Even though we generally refer to them as “shares,” their specifics are not always identical. The following aspects can be set differently:

• Details regarding the distribution of surplus funds
• Details regarding the distribution of residual assets
• Details regarding the exercise of voting rights at the shareholders’ meeting
• Details regarding the transfer of shares
• Details regarding the shareholders’ right to request the company to acquire their shares
• Details regarding the company’s right to acquire shares from shareholders under certain circumstances
• Details regarding the company’s ability to acquire all shares through a resolution at the shareholders’ meeting
• Details regarding the necessity of a resolution at a class shareholders’ meeting
• Details regarding the appointment of directors and auditors at a class shareholders’ meeting

Related article: Issuance of Class Shares and Their Details in Venture Investment Contracts[ja]

From an investor’s perspective, they would want to acquire shares under the best conditions. However, from a company’s perspective, they would want to avoid issuing shares that could potentially give investors control over the company. Therefore, it is necessary to clearly define the details regarding shares in the investment contract.

Content Related to Corporate Management

Many investors who invest in well-managed companies, such as listed companies, may not be particularly interested in the company’s operations. However, in the case of venture companies where management is not necessarily well-established, it is conceivable that investors may become involved in the company’s operations.

Therefore, clauses related to the company’s operations may be stipulated in the investment contract. For example, when a venture capital (VC) invests, it is possible that clauses allowing the VC’s directors to be appointed as directors of the investee company, or allowing them to participate as observers in the board of directors of the investee company, may be stipulated.

Related Article: What is the Clause on Dispatching Directors in Investment Contracts[ja]

Furthermore, it is also possible that clauses may be stipulated requiring the consent or approval of investors when the company makes decisions, or requiring the company to notify investors about certain matters related to the company’s operations.

Details on Investment Withdrawal

Various clauses are stipulated in an investment contract. However, it is possible that a party may violate the terms of the investment contract. Therefore, there may be clauses stipulating the conditions under which an investor can withdraw from the investment if a violation of the investment contract occurs.

For example, a situation may arise where a company violates the investment contract, prompting the investor to withdraw their investment. In this case, the investor may consider selling the shares they have underwritten to the company that issued the shares or to the individual representative of the company, thereby withdrawing from the investment.

Related article: What is a Stock Purchase Clause in an Investment Contract?[ja]

Content Regarding General Clauses

Investors cannot make investment decisions without any information. Therefore, it is customary for companies to provide certain information to investors, and for confidentiality clauses to be stipulated in investment contracts to prevent situations where investors leak information to third parties.

Furthermore, it is conceivable that clauses regarding the duration of the investment contract, discussions between the company and the investor, and jurisdiction clauses in case of disputes between the company and the investor, may be stipulated.

The Importance of Investment Agreements

As we have been discussing the contents of investment agreements, it’s important to note that the conclusion of an investment agreement is not a procedure required under the Japanese Companies Act. It is possible for a company to issue shares without concluding an investment agreement. However, concluding an investment agreement is important for the following reasons.

Not having a contract after receiving an investment is extremely disadvantageous for the company

Firstly, a situation where there is no contract at all regarding the investment is advantageous for the investor, not the company receiving the investment. This may be difficult to understand, especially for venture companies receiving investment for the first time, so let’s explain in more detail.

If only the phenomenon of “the investor has transferred money to the company” exists, the company will be at a disadvantage if the investor decides after the fact that they should not have invested in the company. If only the phenomenon of “the investor has transferred money to the company” exists, it is not clear whether the money is:

1. Investment capital transferred as an “investment”
2. Deposit transferred in advance for 1
3. Money transferred in the form of a loan, etc., without any legal cause

Therefore, the investor can claim a refund from the company by saying, “The money I transferred before was a deposit.” On the other hand, if the investor decides that they should invest, they can ask the company, “Let’s make an investment agreement because we haven’t concluded a contract yet.” Therefore, if “money has been transferred but there is no contract,” the investor has the option to:

• Ask for a refund if they think the investment has failed
• Ask for the conclusion of an investment agreement if they think the investment has succeeded

This is a very “disadvantageous” situation for the company receiving the investment.

If you don’t make a contract, it won’t be confirmed as “capital”

In other words, concluding an investment agreement from the company’s perspective is nothing more than an act to confirm that “the money received is not a deposit or a loan, but money received as an investment, and it is capital.”

Especially in the case of seed-stage venture companies, once they receive a transfer of money from an investor, they will quickly use that money for business investment. Therefore, even if a refund is requested afterwards, there are many cases where the money is no longer in the account. In that case, the above options become even more disadvantageous for the company. The investor can:

• Ask for a refund if they think the investment has failed
• Ask for the conclusion of an investment agreement if they think the investment has succeeded. However, since the company no longer has money in its account, it no longer has the option to refuse to conclude the contract because “the conditions of the investment agreement are disadvantageous.” Even if the conditions are disadvantageous, the company has no choice but to agree to the contract. As an investor, they can “force” any conditions that are advantageous to them

That’s why they have these options.

From the company’s perspective, the state of “having received an investment but having no contract” is extremely disadvantageous.

Investment Agreement and Total Subscription Agreement

However, basically, there will never be a situation where “you have received an investment from an investor, but in the end, there is no contract at all regarding it.”

When a company issues new shares, it must register the change at its head office within two weeks from when the effect occurs (Article 915, Paragraph 1 of the Japanese Companies Act, Article 911, Paragraph 3 of the same Act), and when applying for registration, it is necessary to attach a “Total Subscription Agreement,” so it is necessary to conclude an investment agreement and clarify the contents of the investment.

However, in reality, there are many cases where the Total Subscription Agreement is created not before the execution of the investment, but after the execution, for the purpose of registration. Therefore, in the end, the flow becomes:

1. Conclusion of investment agreement
2. Transfer of money
3. Conclusion of Total Subscription Agreement

And there is a gap between 2 and 3, where “money has been transferred but there is no contract.”

The Necessity of Investment Agreements

Given the reasons mentioned above, it can be said that the necessity of concluding an investment agreement is high. In cases where a venture capitalist (VC) is the investor, it is rare for a situation to arise where an investment agreement is not concluded. However, it is conceivable that the conclusion of an investment agreement may be overlooked in relationships with close acquaintances or friends.

Nevertheless, even if there is a personal relationship, it is possible for that relationship to break down. Therefore, it is advisable to always conclude an investment agreement, regardless of the circumstances.

Related article: The Necessity of Concluding an Investment Agreement in Seed Rounds[ja]

Summary

We have discussed the importance and necessity of concluding investment contracts. Since investments involve significant amounts of money, it is essential to carefully consider the contents of the investment contract and to conclude it. Furthermore, an investment contract is not a simple contract like a sales contract or a lease contract, so please make sure to have it drafted by a legal expert, a lawyer, or have it legally checked by a lawyer.