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What is an Investment Contract?
An investment contract is a legal document between two parties where one party invests money with the intenet of receiving a return. Investment contracts are regulated by The Securities Act of 1933. In order for a contract to be considered valid to this category it must contain the following elements which are laid out by the Howey test:
- An investment of money
- A common enterprise
- Profit expectation(s)
- Derived from the efforts of others
Although the Howey Test it is not the sole testing method available it is the most common resource relied on to confirm that an investment contract meets the criteria of a security.
Types of Investment Contracts
There are multiple types of investment contracts but the ones most frequently drafted consist of the following:
- Stock Purchase Agreement – This type of contract is one of the simplest but involves a ton of documentation since it is for investments that are not publicly traded.
- Non-statutory Stock Option Agreement – Sometimes referred to as nonqualified stock options, this type of contract is opted for when investments are sought by investors or workers within a company. No formal requirements exist for this choice.
- Statutory Stock Option Agreement – Known as ‘incentive’ or ‘qualified’ stock options, this type of contract is under the regulation of the Internal Revenue’s Code. Although there are strict requirements for this option the tax benefits make it worthy.
- Convertible Debt Agreement – This type of contract is known for its creativity of allowing an investor to loan money to a company and be repaid later or gain ownership interest. Three specific types of convertible agreements are listed here:
- Convertible Note – A convertible note is a short-term debt that can be converted into equity in the issuing company. In this case, an investor loans money in exchange for shares.
- Convertible Promissory Note – This note converts debt to equity at a designated point in time, depending on the agreement.
- SAFE Note – A SAFE Note is a convertible security that acts reflective of an option by allowing an investor to purchase shares at a future price. This is not an actual debt and does not accrue interest.
- Restricted Stock Agreement – A restricted stock contract is one that does not make it feasible for an investor to gain ownership interest. Investors of this nature are expected to dedicate time and efforts to maintain existing interest.
- Deferred Compensation – While this is not an outright type of investment, a contract of this category is seen as investing by employees because ownership or pay increases are anticipated for the future.
- Royalty, Commission, or Percent of Revenue – This type of contract is more for individuals who do not wish to have ownership of the company itself but would rather invest in its profits or products.
To view examples and detailed descriptions of investment contract types read this article .
Key Terms in an Investment Contract
While investment contracts can be very broad and constitute a unique variety of terms and phrases, there are several commonalities listed below.
- Shareholder – A party having a portion of ownership in a company in the form of shares.
- Investor – A party who invests in a company by putting forth money or other financial resources. Investors give to the company with expectations of receiving back.
- Investment – Something of financial value given for the purpose of reaping benefits thereafter.
- Recitals – Recitals are the specific details of the applicable agreement, including investments intended to be made.
- Agreements – Agreements listed in the contract dictate all the terms and conditions agreed upon. This is the lengthiest portion.
- Milestones – Milestones are parts of the investment process broken down into smaller areas and timeframes. One milestone must be achieved to get to the next.
- Warranties – Warranties are representations made by a company to an investor that state truths and facts pertaining to the investment. If it is discovered the warranties were misleading or false then an investor can take action based on these.
- Restrictions – Restrictions written in an investment contract will describe the ways in which the investor is limited as to their ownership, shares, or other role in the company.
- Confidentiality – The confidential assertions made in the contract will mandate that the agreeable parties keep information related to the investment private.
Read this article to learn more about key terms that are often placed in investment contracts.
Return on Investment (ROI)
It is likely an investment contract exists if a party invests money into a business without having a direct role in the processes carried out. This party becomes known as an investor and when an agreement is entered into regarding an enterprise a return on investment (ROI) is expected.
It is an absolute necessity that you notate in the contract when the ROI will be disbursed. This will prevent you from having to wonder when the right time is to reach out to about a ROI and will also allow you to inquire about it at a reasonable time. There is more than one formula used to calculate ROI so it is wise to disclose the version that will be used for the exact agreement being focused on.
The most likely formulas to be used are shown here:
- ROI = Net Income / Cost of Investment
- ROI = Investment Gain / Investment Base
A good way to view ROI and determine the best way to make a calculation is to think of the applicable benefit divided by the cost. An investor should be curious of businesses ROI because it signifies the value of the investment being decided on.
Here is an article detailing ROI.
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How To Write an Investment Contract
Professionally and diligently writing an investment contract is highly recommended due to the legal stipulations it creates. Writing an investment contract can be simplified by examining related samples and including all the content listed below:
- The names and addresses of interested parties
- The general investment structure
- Purpose of the investment
- Effective date agreed upon
- Signatures by both/all parties
It is important to clearly state in the contract what you as the investor will be providing and in what form as well as when the investment will be activated. Whether investments will be transferred in the form of cash, check, assets, or wire transactions should be asserted. It is vital to ensure inclusion of all the specifics in the contract no matter how trivial they may seem so that there is no confusion or disputes that arise later.
It would be useful to follow these steps when writing your investment contract:
Step 1: Designate the first section to name the parties involved and link them to the proper titles.
Step 2: The legal terms such as ‘whereas’ and ‘therefore’ should be listed when describing the investment and claiming that the parties agree of the material that follows.
Step 3: The body of the agreement should contain headings and sections reiterating prior discussions of how the investment will be set up and put into action.
Step 4: Once the basics are incorporated into the contract, the terms of payment should be written.
Step 5: Milestones that apply should be spelled out with their due dates mentioned.
Step 6: The start, duration, and end of the agreement should all be touched on along with unplanned termination aspects.
Step 7: Company points of contact, legal jurisdiction, and signatures serve as appropriate conclusive sections.
Here is an investment contract example .
Getting Help With an Investment Contract
If you are thinking of writing an investment contract and need assistance, fundraising lawyers and/or securities lawyers are well suited contacts.
Here is an article that provides insight as to the competency of these attorneys for investment matters.
Meet some of our Investment Contract Lawyers
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I am a California-barred attorney specializing in business contracting needs. My areas of expertise include contract law, corporate formation, employment law, including independent contractor compliance, regulatory compliance and licensing, and general corporate law. I truly enjoy getting to know my clients, whether they are big businesses, small start-ups looking to launch, or individuals needing legal guidance. Some of my recent projects include: -drafting business purchase and sale agreements -drafting independent contractor agreements -creating influencer agreements -creating compliance policies and procedures for businesses in highly regulated industries -drafting service contracts -advising on CA legality of hiring gig workers including effects of Prop 22 and AB5 -forming LLCs -drafting terms of service and privacy policies -reviewing employment contracts I received my JD from UCLA School of Law and have been practicing for over five years in this area. I’m an avid reader and writer and believe those skills have served me well in my practice. I also complete continuing education courses regularly to ensure I am up-to-date on best practices for my clients. I pride myself on providing useful and accurate legal advice without complex and confusing jargon. I look forward to learning about your specific needs and helping you to accomplish your goals. Please reach out to learn more about my process and see if we are a good fit!
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A twenty-five year attorney and certified mediator native to the Birmingham, Alabama area.
I absolutely love helping my clients buy their first home, sell their starters, upgrade to their next big adventure, or transition to their next phase of life. The confidence my clients have going into a transaction and through the whole process is one of the most rewarding aspects of practicing this type of law. My very first class in law school was property law, and let me tell you, this was like nothing I’d ever experienced. I remember vividly cracking open that big red book and staring at the pages not having the faintest idea what I was actually reading. Despite those initial scary moments, I grew to love property law. My obsession with real estate law was solidified when I was working in Virginia at a law firm outside DC. I ran the settlement (escrow) department and learned the ins and outs of transactions and the unique needs of the parties. My husband and I bought our first home in Virginia in 2012 and despite being an attorney, there was so much we didn’t know, especially when it came to our HOA and our mortgage. Our real estate agent was a wonderful resource for finding our home and negotiating some of the key terms, but there was something missing in the process. I’ve spent the last 10 years helping those who were in the same situation we were in better understand the process.
Samantha has focused her career on developing and implementing customized compliance programs for SEC, CFTC, and FINRA regulated organizations. She has worked with over 100 investment advisers, alternative asset managers (private equity funds, hedge funds, real estate funds, venture capital funds, etc.), and broker-dealers, with assets under management ranging from several hundred million to several billion dollars. Samantha has held roles such as Chief Compliance Officer and Interim Chief Compliance Officer for SEC-registered investment advisory firms, “Of Counsel” for law firms, and has worked for various securities compliance consulting firms. Samantha founded Coast to Coast Compliance to make a meaningful impact on clients’ businesses overall, by enhancing or otherwise creating an exceptional and customized compliance program and cultivating a strong culture of compliance. Coast to Coast Compliance provides proactive, comprehensive, and independent compliance solutions, focusing primarily on project-based deliverables and various ongoing compliance pain points for investment advisers, broker-dealers, and other financial services firms.
Experienced General Counsel/Chief Legal Officer