Getting to the point in your business where you have attracted the attention of outside capital providers is quite an accomplishment. The next step—managing a SAFE or preferred stock financing round—is also challenging. It’s essential to prepare well, anticipate your investors’ due diligence inquiries and ensure that your operations can withstand scrutiny. Here are 10 tips to help you make your round go more smoothly:
1. Data Room. Consider setting up a virtual data room (VDR) to make it easier for designated persons to access the disclosed documents securely. Higher-end VDRs have security controls, such as watermarks, print restrictions, user activity reports and notifications.
2. Scope. Due diligence is an essential part of the financing transaction, and thorough responses will help avoid supplemental requests that can cause delays and increase expenses. Some founders may perceive certain requests as “overkill” or unnecessary. Confirm with investors that the requests are indeed important to them, as they are very often overbroad in the first instance. Explain why you believe certain questions may not be necessary or relevant to the transaction and offer alternatives to address any concerns they may have. Follow-up questions should be taken seriously. Ultimately, a willingness to engage in open communication and collaborate on due diligence matters can help build trust between you and the investor. Ideally, you will have one lead investor whom smaller investors can rely on to take up the lion’s share of due diligence requests.
3. Organizational Documents. Investors will want to confirm the legal existence of the organization and understand its history. For most businesses, providing the Certificate of Incorporation, a current Certificate of Status (i.e., “good standing certificate”), Bylaws, organizational resolutions, should be a very simple task. However, often a target business is operated under more than one entity, and in different jurisdictions. A complex history involving changes such as conversions from LLC to corporation, mergers, redomestications and name changes should be described clearly and supported by documentation.
4. Capital Structure. Make sure you have a clear understanding of the different types of securities that your company has issued, such as common stock, preferred stock, Simple Agreements for Future Equity (SAFEs), convertible notes, warrants (including token warrants) and employee equity grants. Any changes in ownership and leadership should be properly documented with appropriate board and stockholder resolutions. A capitalization table will be expected.
5. Financial Statements. Ensure that financial statements are properly prepared and that there are no personal expenses appearing therein. Investors may ask that an independent third-party conduct a quality of earnings analysis to identify any potential issues. Investors may ask for a model showing historic and projected revenues and expenses.
6. Contracts and Agreements. Ensure that all agreements have been properly documented and executed. Be prepared to provide a copy of any stockholders’ agreements and side letters.
7. Intellectual Property. Investors will focus on the Company’s IP, regardless of whether it is registered with a government authority such as the U.S. Patent and Trademark Office. Review any agreements that the company has entered into regarding the third-party use of its IP, or the Company’s use of third-party IP. Be prepared to disclose any IP infringement disputes. If IP is not registered, be prepared to disclose how the Company protects its proprietary interest.
8. Employees and Consultants. Additionally, ensure all employees and consultants have entered into Confidentiality and Assignment of Inventions agreements, and that such agreements are enforceable in the jurisdictions where they reside. Investors may request assurance that the company is compliant with all relevant labor and employment laws. Consider using a third-party payroll provider or a professional employer organization (PEO) to help ensure compliance with local withholding and reporting requirements.
9. Compliance Review. Conduct a review of any potential compliance issues such as wage and hour laws, data privacy regulations, System and Organizational Control (SOC) and securities laws compliance.
10. Tax Matters. Consult with a tax expert to identify potential tax liabilities and ensure that all tax filings are up to date. Investors will likely request details surrounding any correspondence with or notices from taxing authorities. Be prepared to disclose whether recipients of restricted stock have timely elected treatment under Section 83(b) of the Internal Revenue Code, and any withholding issues arising from failure to file.
