Clean House Before Your Financing

Admission: I don’t have a housekeeper, but if I did, I would have to clean my home before the housekeeper comes by, because I don’t want to reveal what a slob I am. Startups thinking about venture capital financing or mergers should adopt the same approach. Before closing the deal, there will be a due diligence process, during which the potential investor or merger partner will want to look at a long list of corporate documents. A certain amount of corporate housekeeping will be necessary to put together these documents, and if a startup has messy, incomplete books and records, it can easily derail the transaction. Scrambling to assemble all the needed records will delay the closing, at best, and poor record-keeping could have the undesirable effect of driving the potential investors to put their money elsewhere.

To avoid the problems involved in trying to organize your corporate records while trying to run the business and close the financing, it’s a good idea to start generating and organizing the records now, well before they are needed. Think of this as cleaning the house before the housekeeper shows up. This will reduce stress later, and is a good exercise for identifying where you might be missing a key document like an IP assignment agreement from a cofounder or license to do business as a foreign corporation. Take a look at this excerpt from a typical due diligence list for a venture capital financing, to get an idea of what kind of records you need to have:

a.     Articles of Incorporation and by-laws.
b.     Corporate minute books and stock transfer records.
c.      Federal and state tax returns and related reports.
d.     Shareholder agreements between the company and its shareholders.
e.     Documents imposing restrictions or conditions on stock transfer or merger, including any arrangements granting rights of first refusal or other preferential purchase rights.
f.      Third-party or governmental consent or authorizations required for merger or acquisition.
g.     Intellectual Property documents, including patents, patent applications, copyrights, trademarks, trademark applications, licensing agreements, etc.
h.     Office leases.
i.       Corporate policies concerning hiring, compensation, advancement and termination.
j.       Employment contracts, including non-competes and IP assignment agreements.
k.     Employee benefits documentation.
l.       Insurance policies.

That list is just a small subset of the full range of documents that an investor or merger partner will be requesting. A quick search on “due diligence document list for venture capital” will generate several free examples of comprehensive lists to guide you.

Another lawyer that represents startups wrote that the most valuable piece of equipment a startup can buy is a good document scanner. While you will want to have hard-copy originals of certain documents, other documents can be maintained exclusively as digital copies. In addition, every document should be scanned and kept in digital form too, as a backup. Scanning can be a time-consuming process, which is why it is good to start now, and do a manageable amount every day.

It’s pretty easy to organize these digital documents into subject areas, with appropriate folders and labels. For example, you would create a digital folder labeled “Employment,” and digital copies of all employment contracts, non-competes, and employee handbooks would go into that folder. Another folder can be created for Intellectual Property, with subfolders for non-disclosure agreements, patents, trademarks, copyright, logos, IP assignment agreements, etc. A third folder will contain your articles of incorporation, bylaws, and minutes of shareholder and board meetings. When the time comes to hand over copies of these various documents as part of due diligence, you will already have them in digital format, well-organized, and ready to copy to a disk. Your closing process will go more smoothly, you will save a little on attorney fees (theoretically), and your investor or merger partner will be impressed by how organized and prepared you are.

Follow me on Twitter @PaulHSpitz