By Leslee Cohen
I am a startup lawyer who focuses on representing founders in connection with their early fundraising rounds. I have a particular passion for representing female founders.
I have learned the importance of having your legal ducks in a row before starting the fundraising process.
First, investors are likely to be more interested in investing if they see that you have taken the time and energy to do it right from the beginning, which could even increase your valuation.
Second, you will save yourself that crazy last minute effort and the legal fees it entails to get everything done quickly. You will also have the opportunity to identify any issues that need to be resolved before an investor starts the due diligence process and spots them.
When I talk about getting your legal ducks in a row for early round fundraising purposes, I mean properly documenting the corporate organization of your business.
At a very elementary level, you must form an entity, whether that is a corporation or limited liability company. Do so by making a filing with the state. You must also have registered that entity to do business in any state outside of its state of formation that you have either a facility and/or employee. In other words, where business is being conducted.
Next, you need to document the governance structure for your entity. If it is a corporation, that means having your incorporator appoint a board of directors and adopt bylaws. Then those directors appoint officers through organizational resolutions (basically, written consents). If is it an LLC, that means having the formation documents reflect whether the entity will be managed by “managers,” which is akin to a board of directors, or “members,” which are the owners.
You also need to have documents reflecting the issuance of ownership in the entity. Again, for a corporation, this would entail Stock Purchase Agreements. Keep in mind that very often startups instead enter into Restricted Stock Agreements because investors like to see founders’ equity vesting over time. That means the founders own their equity but it is subject to forfeiture if the founder leaves the company before their equity “vests.”
If there is more than one founder and/or the startup is also issuing equity to new employees or advisors who have been helpful along the journey, then I highly recommend having a Shareholders Agreement that governs the relationship among the shareholders and covers such issues as what if a founder is not pulling her weight or something was to happen to one of the shareholders. I doubt you would want to remain in “partnership” with a third party who inherits your co-founder’s shares and may be someone you don’t even know. For LLCs, all of this can be accomplished via what’s referred to as an “Operating Agreement,” including the issuance of interests (which is the same as shares for a corporation) and the guidelines for the relationships among the interest owners.
Investors will want to see that you have properly documented your relationship with any employees or service providers such that any intellectual property (ideas, concepts etc.) they develop while working with your company belongs to your company and not to them individually to use for other purposes. That means having Confidentiality and Proprietary Information Assignment Agreements in place as well as documenting any equity issuances (see the immediately preceding paragraph).
Finally, you will want to be able to show potential investors a capitalization table with how much equity is authorized to be issued, how much you have actually issued and how much you may have reserved for issuance to incentivize employees and service providers until you have the resources to pay them in cash.
Of course, there are additional documents relevant to each business that you should think about such as strong contracts with your customers and vendors. I highly recommend that you speak with a lawyer about those as well.
Having all of these documents in place and, even better, putting them in an electronic data room, should help put you in a great position to attract early stage investors.
Leslee Cohen, lawyer at AllRise
