Venture capital funds don’t expect startups to be well-oiled machines. In fact, they go into potential deals knowing there will be problems. These issues range from disgruntled founders to disputes over who owns a company’s intellectual property. Acquirers are prepared for these issues and M&A and venture capital professionals will not be surprised to uncover some of these issues during the diligence process. However, when preparing for equity financing it is important that your company does not have the kinds of problems that may be so fatal that it kills your deal.
Establishing and maintaining good corporate hygiene will pay dividends as you negotiate your venture financing. By preparing in advance, you can minimize some of the pain and effort in the diligence process and focus instead on negotiating the best deal for your company.
Here are some tips on how you can properly prepare for your equity financing.
1. Create and maintain a reliable capitalization table. Your company’s capitalization table is the first item any potential investor or acquirer will ask to see when considering an investment, acquisition, merger or strategic transaction. Your capitalization table should include who you have sold stock to, for what price and in what quantities, whether those shares have certain voting rights and other related information. When you pitch to a VC firm and they are interested in your idea you don’t want to make them wait an additional week as you scramble to contact your investors to see who owns what and to create your stock table. Your ability to quickly furnish a clean and accurate cap table will impress investors and give the impression that you are organized and in command of your business. As your company grows, your capitalization table will be your first point of reference for handling stock options and tracking compliance with regulatory requirements. Outside counsel or an accountant should prepare and maintain your cap table.
2. Protect your intellectual property. This issue can quickly kill a deal. Simply, if you are reading this and your intellectual property is not registered or if there are any disputes, stop right now and register your IP or solve your disputes. Your IP is potentially your most valuable asset and your investors know that. Before they make a sizeable investment, they want to ensure that your company has a clean record with respect to owning and protecting its IP. The first task you should undertake after forming your company is to get each and every individual or entity
that has worked on the company to sign bulletproof (and enforceable) confidential information and IP assignment agreement. There are many model agreements available on the web but as with any model it is just a start; make sure that your model agreement is tailored to your jurisdiction and is enforceable where you do business. Failing to accomplish these steps can torpedo your deal before it ever gets off the ground.3. Corporate Governance. Corporate governance is an essential part of good corporate hygiene. When preparing for an equity financing one thing you want to get together from a corporate governance standpoint is to ensure that the company’s minute book is in order and up to date. Along with this you should gather the company’s bylaws, articles of incorporation, stockholder consents and minutes. Make sure that you have licenses to do business in all jurisdictions where the company does business. Confirm that board and stockholder actions have been properly documented and signed. For example, if there is a share transfer or if there was an instance where the company took on more debt, did these events follow the proper corporate protocols that you have put in place?
4. Regulatory Matters. When preparing for your equity financing, it’s important to ensure that your
regulatory filings have been made. This includes any filings required for securities exemptions, tax related filings and any other material filings required in connection with your business. For example, if your company has a security interest in inventory somewhere be sure that you have filed the necessary UCC-1 Financing Statement perfecting that interest. If a company stockholder wants to make an 83(b) election for restricted stock, has that filing been made? Making, and having evidence of, this and other filings is a great way to inspire confidence during the diligence process.5. Company Agreements. If you have entered into any material agreements such as share purchase agreements or share transfer agreements be sure to have copies of each of these agreements ready for review in the diligence process. These agreements can also include IP licenses, office leases, any agreements with suppliers, vendors and customers or any other agreements that may have a material impact on the company’s ability to conduct business.
6. Familiarize Yourself with VC Terms. Founders range from very sophisticated to novices and everything in between. No matter where you are on the spectrum it is a good practice to familiarize yourself with equity financing terms. There are places on the web where you can gain access to
many model term sheets and model agreements but the ideal situation is to sit down with an attorney as you prepare for your equity financing. You should have her explain to you such terms as “redemption rights,†“pre-emptive rights,†“pay to play,†“liquidation preferences,†etc. You will undoubtedly see these terms during your financing round and you don’t want your first time hearing them to be when the VC asks you if you are ok with not having any pre-emptive rights; or with the VC having a liquidation preference of ten times the original purchase price.Conclusion
While many of these issues may seem like ancillary matters that are not germane to your day-to-day business, they make the difference between a deal or no deal. A small investment in time or legal fees will be enough to put these protocols in place and go a long way in instilling confidence in your investors. We have helped many startups and growing companies prepare for their equity financing round and would be pleased to help you prepare.
For more information on the topics covered in this memo or to learn more about our services, please contact one of our attorneys at contact@rbernardllp.com or visit our website to learn more at www.rbernardllp.com.