Money is the lifeline of any business, without funding is it practically impossible to expand or even grow your business. Oftentimes Entrepreneurs seek venture capital or external investment from angel investors.
Many times these startups assume that all they need is a disruptive business concept and a clear path to growth. But this isn’t always the case,. Below we explore five of the most important legal issues that professional investors are likely to review in a standard due diligence process before deciding to make an investment in an early-stage company.
- Corporate Governance
Whether your company is a corporation, limited liability company (LLC) or partnership, when seeking investment, you should ensure the following:
- the basic governance structure is finalized and agreed to by all stakeholders;
- the organizational documents are adequate and complete;
- all agreements of the board of directors/managers or shareholder actions are properly reflected in the minutes;
- Additionally, the company should be treated as a separate entity (and not as the alter ego of the founders or of another business);
- and the equity records of the company should be complete.
Upon deciding whether to make a venture investment, an investor will likely request a review of these organizational documents to gain a better perspective of the actions the company has taken in the past. One of the most common mistake startup companies make is that they fail to address properly ownership and measure of equity owned which leads to avoidable problems. This can be avoided by seeking legal counsel at the onset to ensure that it is done correctly.
- Shareholder Agreement
The easiest way to make clear what all of the equity holders’ rights are in a company is to have a shareholders’ agreement. Some of the pivotal provisions of this agreement include:
- Voting arrangements,
- restrictions on share transfer,
- “tag and drag” rights in the event of a sale,
- anti-dilution provisions and
- rights of first offer or refusal.
In my experience, many startups discuss these issues verbally some even prepare drafts but never get to the signing stage and this leads to uncertainty for subsequent investors in the company and what rights all parties involved have. The absence of a final and signed shareholders’ agreement may also allow certain equity holders to block a potential venture investment and to hold the transaction hostage unless they are given preferential rights.
- Intellectual Property
If your company is centered around or built upon its intellectual property, then it is essential that there is no confusion about the ownership of intellectual property associated with the company. An investor will expect to see signed intellectual property assignment agreements, assigning any potential ownership rights or claims to the company. Furthermore, depending on the nature of your intellectual property, it is essential that you conduct proper due diligence to confirm that you are not infringing on third-party intellectual property right.
- Written Contracts
Although an agreement does not have to be in writing to be enforceable, it a good idea to ensure that all of your material agreements are in writing, contain all important terms, and are properly signed by all parties. The kinds of agreements that should be in writing include:
- vendor and supply agreements,
- customer agreements,
- warranty and guaranty terms and
- employment agreements
Prior to making an investment, an investor will likely request to review your material contracts to gain a clearer picture of your business’ obligations.
One key thing you must note is that, when negotiating a written contract, some third parties will include certain provisions within the contract, including indemnification, non-compete, license, and limitation of liability provisions which may impact negatively on your company, so be on the lookout for these provisions because they eventually become an issue during investor due diligence and may adversely affect your company’s value to a potential investor. As always, make it a point of duty to get legal help before you sign a contract.
- Understanding the Regulatory Issues relating to your business
Maneuvering the regulatory landscape relating to your business is a must. For example, if your business is in the tech space, you must ensure it is in tune with data privacy laws of the country of Origin and adheres to regulatory provisions. Before making an investment, investors will want to ensure that your business plan is not endangered due to regulatory concerns. It is essential that you see legal counsel to help you identify any potential regulatory issues and to confirm that such regulatory issues where they exist will not adversely impact your business model.
About the writer:
Omoruyi Edoigiawerie is a Legal Practitioner and Lead Partner at the Law firm of Edoigiawerie and Company LP – a full service law firm with depth of proven experience and expertise in corporate commercial transactions and a strong bias for Startup and Entrepreneurship Law.
He is a member of the Nigerian and American Bar Associations as well as several professional bodies.
Omoruyi is the brain behind the UyiDLaw brand where he shares very insightful Legal nuggets (UyisNuggets) to help businesses grow and thrive. Through his platforms, he provides mentorship and business linkage support.
He can be reached at firstname.lastname@example.org.