We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.
On the legal side, the following is a list of key areas that investors often focus on and how to prepare for them:
•Corporate Governance. Make sure that the company’s minute book is in order and up to date, including the certificate of incorporation, bylaws, board and stockholder consents and minutes, and certificates from all states and jurisdictions where the company does business. Confirm that board and stockholder actions have been properly documented and signed.
•Securities. Make sure that the capitalization table and stock ledger match up with the common stock purchase agreements, stock certificates, option grants and agreements, warrants and convertible securities, and make sure that there are no outstanding (but not papered) promises made regarding securities of the company. Confirm that all applicable securities filings have been made and that 83(b) elections, if any, have been filed.
•Intellectual Property. Make sure that all employees and consultants have signed IP assignment documents, that all other necessary IP assignments have been made, and that ownership of the company’s intellectual property, including patents and trademarks, is clear.
•Material Agreements. Make sure that you have copies of all signed material agreements. Material agreements include IP licenses, real estate leases, all agreements with suppliers, partners, customers and vendors, and any other agreements or arrangements that can be considered material to the company’s business.
Concurrent with preparing for the due diligence process, you should get a basic understanding of what a standard term sheet for an equity financing looks like (our term sheet builder is available here) and the current market terms. It is also important to learn the meaning of some basic equity financing terms, including “antidilution,” “liquidation preferences,” “pay to play,” “redemption,” “protective covenants,” “registration rights,” etc.
Raising funds, particularly venture capital funds, can be a long and often arduous process. By preparing in advance, you can minimize some of the pain and effort and focus instead on negotiating the best outcome for your company.
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