Venture Capital Due Diligence Checklist – Part II

By Drew Stevens - March 16, 2019 - Startups + VC

In our last post, we started to dive into what startups can expect once they’ve signed a term sheet with a venture capital firm. Venture capital firms take due diligence seriously, and it can be intimidating to work with a Columbus venture capital law firm.

Startup founders and officers who take due diligence equally if not more seriously can work to ensure that their VC funding does not fall apart during due diligence. In this Part II, our very own Columbus business startup attorney will cover additional key areas including regulatory issues, securities, debt financing, and litigation.

Startup Regulatory and Compliance Issues

This category can often be industry, service, or product specific. For example, if you’re in beverages, the VC firm may want to see all action and correspondence with the Food and Drug Administration.

If you’re in telecommunications, the VC analysts may want to look at any action or approvals with the Federal Communications Commission.

If you’re construction, clean technology or utilities, agriculture, automotive, or transportation, the VC firm may want to review Environmental Protection Agency compliance.

You get the point – if you’re subject to certain compliance requirements, make sure you have great and organized records of applications, approvals, and correspondence.

Securities Laws and Startups

In our last post, we touched on your capitalization table and documentation of equity ownership. If, prior to VC funding, you’ve issued equity, you may have invoked securities laws. If you haven’t filed any kind of SEC registrations, be sure to know what federal exemptions you fall under.

If your federal exemptions don’t preempt state exemptions, also be sure to know which state exemptions you fall under. Even if you’re using one of the more popular exemptions like Regulation D, double check to make sure you haven’t skipped basic compliance requirements.

For example, if you’re relying on all your investors, prior to signing the VC term sheet, being accredited investors, be sure that you’ve taken proper steps to document their status as accredited investors and no one is in fact a non-accredited investor.

Remember that with securities laws, the onus is on the company to be able to prove that it meets the requirements for falling under the exemption(s) claimed. One of the last things you want in venture capital due diligence is to show a complete disregard for securities laws.

Documentation of Debt Financing

In addition to equity and securities, VC firms will want to look at any and all debt financing you may have. Be prepared to disclose full loan terms and agreements. If UCC-1 financing statements were filed on any collateral, also have those ready. Debt financing also includes line of credit agreements.

Litigation

Maybe you have current litigation or threatened litigation. Don’t despair. Contentious litigation can be de rigueur with cutting-edge technology or in highly competitive industries. The worst thing you can do is attempt to hide or not disclosure threatened, pending, or current litigation from your venture capital firm.

Good VC analysts can search federal and state records to find current litigation. You may be tempted to not disclose threatened litigation or issues because no suit has been filed and you’ve been told there may be an early settlement. But, if said issues come out prior to closing VC funding, best of luck with that. Full and honest disclosure is your friend here.

Your VC firm may even welcome said litigation or issues if such action brings about a faster conclusion to messy issues. The VC firm may also have resources or advice on bringing these issues to a faster and more efficient resolution.

Miscellaneous

Lastly, a general rule of thumb in preparing your startup for venture capital due diligence is that the VC firm is going to want to see any legal document or agreement that speaks to a major asset or liability of your company.

For example, the VC firm will certainly want to look at your office and warehouse leases as a part of analyzing your expenses and burn rate. In reviewing your intellectual property, the VC firm will want to see any joint venture agreements or licensing agreements you have. The VC firm will also want to see any major services agreements that you may have with marketing agencies or third party materials.


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