Having your legal documents organized is a startup superpower. It’s not sexy and it’s not fun. But it will set you apart from the vast majority of other startups when it comes time for due diligence.
Due diligence is unavoidable. Any fundraising or acquisition opportunity will hinge on a due diligence process where potential investors or acquirers (and their lawyers) get to look under the hood of your startup. If serious errors are discovered during due diligence, investors or acquirers may walk away. At the very least, they’ll use these errors as leverage to negotiate terms more favorable to them.
Now it’s possible your startup has correctly done various legal tasks like incorporate, issue stock, get IP assignments from service providers, authorize an option plan, etc., but what matters most come due diligence time is that you can show your work. That means producing a paper trail documenting that everything you should have done has been done in the right way and at the right time. This starts off as a relatively easy task. You might create a file folder titled “legal” or something like that and save things like the corporation’s governing documents, employment/IP agreements, stock purchase agreements, and the like.
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But as time goes on, the number of documents can swell and the number of people who are handling them may multiply. Time and time again, this informal process breaks down and startups end up with a bunch of documents that are missing. A common example is an unsigned Word version of the document saved but no executed copy. These problems can sometimes be solved, but they inevitably take time even if there is a solution to be had. For an established company, that loss of time might be inconsequential, but for a startup burning through money and in need of a timely capital infusion, it could mean curtains.
To avoid this fate, startups should set up a data room as soon as possible where all of its legal documents will live in a structure meant to facilitate the due diligence process. Your lawyer can be a big help in structuring this by sharing what requests you should expect in connection with due diligence. In fact, this exercise can itself be very illuminating to startup founders in understanding what legal tasks are actually important, which can then make them more effective at legal issue spotting and knowing when to call their lawyer. For example, if there’s a heading or category in the data room and you don’t know what kind of documents should live there, you might be overlooking an important legal task. In other words, the structure itself can prompt you to ask better questions.
This is a classic example of how proactive and collaborative work with your lawyer will maximize value in the long run. It’s always more cost effective from a legal standpoint to do things right from the start than it is to try to clean up a mess that’s already been made. And the stakes are higher than legal fees—a disorganized startup may lose out on funding or acquisition opportunities due to disorganization.
