Investment Contract: Types and Key Terms

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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 intent of receiving a return. Investment contracts are regulated by the Securities Act of 1933. 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
• An expectation of profits
• Profits derived from the efforts of others

Although the Howey Test 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.

A few examples of commonly used investment contracts are below:

• Stock Purchase Agreement
• Convertible Note
• Promissory Note
• SAFE Note
• Limited Partnership Agreement

Types of Investment Contracts

There are multiple types of investment contracts but the ones most frequently drafted consist of the following:

1. 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.
2. 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.
3. 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.
4. 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:
5. 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.
6. Convertible Promissory Note – This note converts debt to equity at a designated point in time, depending on the agreement.
7. 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.

1. Restricted Stock Agreement – A restricted stock contract governs a transaction where stock is issued but vests over time and may have other sale restrictions. The receiver of the shares does own the stock, but may need to meet certain requirements until they can sell it.
2. 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.
3. 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.

See Investment Contract Pricing by State

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.
• Vesting. The process of a shareholder earning the rights to own certain stock over time or based on achieving certain milestones.

Read this article to learn more about key terms that are often placed in investment contracts.

Darryl S.

Peter L.

Forest H.

Pura R.

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.

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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.

Please note, for a transaction of this importance, it is always recommended to seek advice from a financial lawyer to make sure your rights are being protected within the contract.

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.

ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.

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