How to Prepare for Legal Due Diligence
What is corporate hygiene, why does it matter, and what should you do about it to prepare for legal due diligence?
(40 min)
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Jason: Today we're going to discuss how to prepare for confirmatory due diligence that investors will do before making an investment in your company. Typically, you can expect potential investors to do business-oriented due diligence and also legal oriented due diligence. In this video, we're really going to focus in on legal due diligence, especially the topic of corporate hygiene, which is something you can and should prepare for in advance of raising capital.
Joining me today is Aaron Berman, who's a partner at Goodwin, one of the top legal firms in the country. Aaron has experience helping founders and CEOs prepare to raise capital all the way from early angel rounds through IPOs.
Aaron, let's start with a little bit about you, your business background, the types of companies you've worked with, and anything else you want to share.
Aaron: Yeah, Jason, thanks so much. Really appreciate you having me on today. Um, fantastic to be getting a chance to chat with you about this. Um, as uh, as you mentioned, I'm Aaron Burman, partner at Goodwin's um, practice. We're focusing on technology companies. I focus on the full life cycle of technology companies. So everything from um companies that have just been founded all the way through public companies and everything in between venture capital financings, M&A transactions uh and the like.
Um my typical clients are in um software of various types, AI of course being the hot button topic these days. Um a lot of cyber security companies um and various other types of um of SAS enabled platforms. Um also work with a number of uh companies that are fusing hardware with software. So in the engine development space uh 3D printing and other technology enabled applications.
Jason: Great. Well those are fast growing technology and technology enabled businesses which lend themsel or typically will have the kind of risk profile that would require them if they're going to raise capital to raise equity capital which is a little you know similar to what we do a lot of at pitch career. We also want to get people prepared for raising, you know, a small business loan or a debt round or even grant capital. But everyone, usually the press promotes and talks a lot about equity capital. So, I think we'll focus on that today. Probably gear the discussion a little bit more towards the angel round and the early rounds. Uh, obviously, as companies get bigger, they have huge, you know, they have a lot more resources when they're getting ready to go public. So let's focus on those earlier rounds as we kind of dig into this topic more of corporate hygiene.
So let's just broadly part one you know why does a founder CEO care about corporate hygiene or why should they care you know what is it and why does it matter for an earlier stage startup preparing to raise capital.
Aaron: Yeah, thanks Jason. Um, it's a good question and it's one of those where people say uh corporate hygiene and I think you know a lot of times immediately tune out as not the most exciting concept in the world and especially not compared to the really exciting things that are um that my clients are are working on on the actual business side of things. But it's a a vital component of of running a business. um and especially for an early stage business, it really um tees you up to raise capital uh and be a fundable company.
So, what we're talking about with corporate hygiene is uh preparing your legal administrative records, documentation, compliance practices, having all that in line so that it's ready to go when you have an investor that comes in the doors. Um it can help uh protect you and your co-founders from personal liability. Um, it can prevent a lot of expensive problems that can come along down the road if things are done wrong the first time and need to be fixed later on and it just makes you look good in uh in front of the folks that are going to be funding your business.
Jason: Yeah. And one of the things I talk about um in you know our in-person kind of lessons and classes is the concept of momentum, right? And it's the, you know, everyone over, I feel like over rotates or overfocuses on the pitch deck, right? What kind of what you see on Shark Tank.
But, uh, it's interesting. Shark Tank releases their data all the time and there's been a number of articles over the years. I just saw an article recently uh, within this last year or even six months. And basically statistically 50% when you see the deal and they make a deal on Shark Tank, 50% of those deals don't actually close when those sharks get into their confirmatory due diligence. And that's a lot of what we're talking about today, right? What you'd be doing for an angel round will be probably a little bit more rigorous than what the sharks do, but similar. And then you really want to be planning for what about, you know, what do you do for your first seed stage or your venture stage round as well. And that's what we're really talking about.
And I tell people the time to prepare for this is really when you're preparing your pitch materials because you want to keep that momentum. When you have those investors interested, you do eventually get a chance to pitch and they want to learn more. You want to have your corporate hygiene and everything else ready to go. Have it in your virtual data room. So you can keep that momentum with investors.
But um I think what you touched on is there's a lot of issues behind that in terms of personal liability um problems you can save down the road. And it is hard work, but it's work that needs to get done. But maybe that's a good segue into what are some of the common corporate hygiene mistakes that early stage founders make. you know, the ones that you really just with a little bit of effort watching this video and talking to your corporate lawyer, you should be able to avoid.
Aaron: Yeah, I think that's the key, Jason. They're they're totally avoidable problems. Um, and you know, we want to keep it that way so that that way you've worked so hard on on the pitch, worked so hard on the business. let's not have a legal hiccup along the way be the thing that causes the investor to go I've got other things to do with my time and my money.
Um so some of the things that I've seen pop up most frequently um is one it's around the setup of the business in the beginning the conversations that you have with your founders um and the other people that you bring on at the early stage to help you get the business up and off the ground. really common problem there is not talking and having those frank conversations and putting things down in writing around what founder equity splits are going to look like. How much of the company do you own? How much do your co-founders own? How much does the consultant that you're giving equity to instead of a full uh you know their normal hourly rate? How much are they taking of the company?
Aaron: The corollary to that right is is vesting schedules. Um, it's always an awkward conversation to have with your co-founders to say, "Hey, if you leave the company, I get to take your shares back." But from their perspective, the flip side is true as well, right? If you leave the company, should you be able to keep your full set of equity and be able to uh, you know, ride off the um, uh, to to benefit from the um, the business that they build with their sweat equity going forward.
essential conversations to have, easy to gloss over, but it's, you know, one of the first things that, uh, I find uh, angel investors and and seedstage investors are looking to make sure is squared away.
Jason: Yeah, that's interesting. Um, you know, before you've actually had to go out and raise capital, you're kind of in that sort of you're putting your sweat equity and you're putting your own a little bit of capital in to get it going. Maybe you've got some, you know, friends and family, but it's really that angel stage when this is going to be a forcing function.
I mean, once you bring in your first angel investor, um they're going to look for this type of thing and due diligence and this work has to get done. And like you said, it's easy to get busy and not want to um to do all these things. But when you know I always tell folks when you're putting your pitch materials together, you need to be putting together your virtual data room with the things that we all know potential investors are going to look for because you know again you want to keep that momentum.
When should founders start thinking about caring about corporate hygiene and how can they go about doing it? what can they do themselves early on and what do they really need to bring a experienced lawyer in to help them do?
Aaron: Yeah. Um, all all great questions. I think the there's a number of pieces to it. So, one, start from day one. You know, have those conversations with the people that you're actually starting the business with um that are helping you get this thing off the ground. Have frank conversations about who's going to be running which aspects of the business and who's going to own what.
Um, those conversations can evolve over time, but you want to put that down in paper and you want to get the equity issued before you have the conversations with the angel investors. Uh, there's some uh tax reasons that you'll want to do that. You want to issue the stock while the company doesn't have a value.
Once somebody's come in, invested, it may have a value, and you can't get the stock issued in a in such a cheap manner as you can before those conversations have started.
Aaron: Um, in terms of the kind of getting the paperwork in place, it's so easy to do these days. I wouldn't go to a legal zoom or ask chat GBT to do it yet, although it's getting pretty good these days. Um, but most of the major law firms, Goodwin included, have got founder specific sets of documents, a suite of documents that'll help you get set up and ask you the questions around who owns what, who's going to be on the board of directors, uh, what does vesting look like.
All of those kinds of questions get teased out through a questionnaire and then it'll provide you with documents that have been vetted by council and at least get you that starting point where anybody that comes along and looks at them um in in due diligence is going to say great you went somewhere where I know the documents look good and you've made the decisions that you need to make um and everything's buttoned up on the equity uh ownership and the formation of the company side of things.
Jason: So you mentioned a couple things that are really are interesting. Um and uh let's just dig into a couple of those. So you you mentioned the importance and this would really because we want to focus a little bit more on the angel round, right? Those the founder CEO hasn't done it before, right? And and avoiding the common mistakes.
So you mentioned that it's important from a tax perspective, right? to to do to to make the equity issuances and certain things because if you wait till later when the when the company has a value, right, and and for an angel round, you're going to be a convertible note with some sort of a cap, but there could be a a value associated with it. And right now, you actually have to if you wait, you have to issue the stock at a higher price.
So, there's actually an economic incentive here. There's a carrot. That would be the carrot, right? If if I were a founder, hey, I I want to make sure that I'm getting stock at the lowest possible price. Um, and that's a carrot, right? The the stick is I want to put myself in a situation where I lose momentum with the investor or worse even worse than that, I end up having personal liability because I didn't take care of the basic blocking and tackling for corporate hygiene.
Um, but in terms of those documents, like let's let's say I'm at an accelerator. Um, is there I'm guessing probably most accelerators these days have some kind of legal guidance, right? But if they wanted to get uh the corporate packet of documents through, you know, Goodwin or or similar law firm, do those law firms have like programs for really early stage companies to just kind of help them get going? What does what does Goodwin have? I'm just curious.
Aaron: Yeah, absolutely. Um so yeah, most accelerators will have relationship with a major law firm that'll help them with exactly this. If you're not in an accelerator program and want to still, you know, do the right thing in terms of getting all the documentation suite that you'll need, um, most of us have just the plane documents and a questionnaire that kind of guides you through preparing them, um, on our websites available for free.
So you can go in, punch in the information about who your founders are, um, and what percentage of the company they should own, um, you know, few other questions about kind of the setup, and it'll spit out, um, a charter or certificate of incorporation, which is the document that you file with the Secretary of State and says how many shares are authorized um, and covers a few other basics around the equity side of things.
It'll give you a uh a shareholders agreement where you agree with your founders who the board members are going to be, how you're going to vote on certain key important items for the company. Um it'll take care of the kind of the blocking and tackling of early board minutes um and board resolutions to found the company, issue the stock properly so that that way you you hold stock that you've paid minimal amount for as opposed to waiting till later.
Um, it'll give you some basic uh IP documents. So, a basic kind of consulting agreement to use with people that's got the right provisions to make sure that the company itself owns the IP. And that's kind of a a key point that we can touch on in a in a little bit.
Jason: Um, but it'll give you all of those items which you can then take and run with yourself. If you want a little bit more of a kind of bespoke package and want to talk about what some of the decision points are um and and have some other questions, uh yeah, you know, we certainly offer um companies uh a fee deferral program um where you can defer fees for a period of time until you're funded um or or a few months uh from from starting the services.
That’s interesting. that. So, so in theory I and I'll probably get that exact website link page from you and put it in this video.
Aaron: Yeah,
Jason: a good strategy would be, hey, if this is my first goround, I should go there, get those documents, do as much as I can myself, then I could circle back as I get and put, you know, use that in my virtual data room. But as I get closer to a round, right, and I'm really ready to go, I could come back to Goodwin or, you know, in theory another law firm or whatever law firm. I'm sure others do this as well.
I could come back and do kind of a fur def fee deferral kind of arrangement for the to get the right legal services and then be able to pay for them later after I've closed the round. So that's kind of an interesting strategy and I think actually something I wasn't aware of that I would do if I or I would recommend that people do if they're kind of doing it the first time and it's their goound cuz maybe they can get 50 or 70 or even 80% of the way there with the free documents and your free you know from your website and then you know the tuneup um right before they're getting close you know they've got the virtual data room set up they're ready to to pitch an investor and the kind of tuneup with someone like yourself or someone else at Goodwin um would be a lot less because they've done some of the work themselves, right?
They're kind of oriented towards it and then it would be a really good bang for the buck to get you to take a look at it before they actually really give it to their investors in their virtual data room. So, that's an interesting strategy.
Aaron: Yeah. Yeah. I think that that works well for a lot of folks. You know, I think you either I think starting with the website form is is a great way to go.
You know, there's a few things you have to kind of remember to do with that. Um, and where I think it can sometimes be worth get the documents generated. Come to somebody at the firm and say, "Hey, you know, I've I've used your document generator. I want, you know, just give it a quick give it a quick review. Make sure that it all looks good to you. Didn't miss anything. and just, you know, help me make sure I hit the next steps.
Um, to get the charter filed properly, to get everything signed up, um, and make sure key one is to make sure that I filed my 83b election, which helps with tax consequences down the road. Yeah.
Um, and make sure all that's done, you know, in the right way. And that's a pretty inexpensive process. And again, yeah, if you're close to funding and things like that, can work on fee deferrals and things that can help um, you know, spread some of that cost until you've got money coming in the door.
Jason: Good. All right. Great. Well, I love I really like that strategy. Um, okay. Let's talk more. Now, we're we're angel investors, right? We're we're going to raise this angel round. We're, you know, founders, CEOs.
Let's put ourselves in sort of the shoes of the angel investor, their mindset, right? What are they going to care about? What are they going to expect to see when they get interested, right? I I go and I pitch their angel group and they're interested, right? I need to have my virtual data room ready to go. What are they really going to care about? You know, what are the key items that um that are just, hey, they've got to be in there.
Aaron: Yeah. So, there's a few buckets of things that I think angels are really focused on that kind of go to the fundamental core. Is this business the thing the thing that I'm investing in? Is it really what I think it is? Is it owned by the people who say that they own it?
And so one is, you know, the the docs that we've talked about already, the charter, the issuing of the stock, investing. Do we know who owns the company? Are there any questions about other folks that might have a claim to the company? So, be looking at at those initial set of documents there and any other equity issuance doc uh that you've done after that point.
Seeing that, you know, there's a oh, I've promised equity to this person and this person always leads to more questions after that. uh make sure you're buttoned up on actually issuing equity the right way.
Um the other kind of bucket that folks are looking at is IP. So we've got a business, we know who owns it. Does it own the technology that it needs to in order to operate its business? Um did the founders contribute all of the IP that they hold in their heads and were developed elsewhere? Um did they contribute that properly into the company?
That's again kind of a a suite of docs that you'll get from the from one of the um document generators. Um but the founders will b essentially say I in exchange for my stock in the beginning I'm contributing all of the IP that I've developed that's related to this company and by the way I had the right to contribute it. I didn't develop it while I was working at Google. Who would then own this IP?
Jason: Super important, right?
Aaron: Absolutely. It happens all the time that you know look you have a great idea while you're working somewhere else. Gotta be really careful about not using that company's computer to do the work that you're doing here. Don't do it on your time in the office. Keep everything completely separate so there's no question about who owns that IP that's critical for the business to move forward.
Jason: Yeah, that's an important point for sure.
What about like contracts, liabilities, things like that?
Aaron: Yeah. Yeah, that's that'll be, you know, earlier you are, the less that'll kind of matter. But, you know, key ones that folks will be looking at are some of the consultants that you've brought in, somebody to help you do coding.
Um, does it is it clear about, you know, what their compensation is going to be? Is it clear that they're contributing all of their IP to the company?
Um, you know, what are the terms of their engagement? Um, if you've, you know, a little bit later stage, if you're starting to, uh, use, you know, vendors or if you've even got customer contracts in place, usually not digging in too deep on what the terms of everything included in those agreements are, but looking at the key pieces.
What are the outflows of cash that we've committed to? Are we going to have to pay for an expensive lease on an office space? Uh, and is that where my capital is going to go, or can it go towards building the company? Yeah.
Jason: Um, you know, other loans that you may have taken on as a company before this round of investment, you know, all of that's critical for the investors to be able to understand where their money is going to be spent and they want as much as possible to be spent on building the business.
Last piece is a little more Sorry, sorry, Jason, cut you off.
Aaron: No, no, no. Please continue.
Jason: Yeah, just the last one is around kind of some of the compliance and regulatory stuff. Like there's not there for an early stage company there doesn't tend to be a lot on this side of things but um you know certain businesses will if you're uh dealing with personally identifiable information of your user base um especially if you're dealing with um you know information regarding uh minors um if you're working in with you know highly critical kind of technology um that uh has you know kind of national security implications which is surprisingly easy to do.
Aaron: Yeah.
Jason: Um there can be regulatory overlays for that that you know you may need to address. Most folks in those spaces if it's it's one of those highly regulated industries, you know, have a good background on that from before. Your investors are not expecting you to have a full compliance team up and running and things, but they want to know that you're aware of what the landscape looks like and if there's anything that critical to happen in an earlier stage that you know you're on top of it and can get it done in a timely manner.
super helpful. Yeah, I mean Camden spun out of Tro Price in the Baltimore DC area for a long time and you see a lot of companies even the ones we don't invest in but you know a lot of government contracting government services companies around you know cyber all that any really government contracting companies run into that issue all the time.
Aaron: it's a whole fun kettle doing the uh doing the whole government contracting side of review. But yeah,
Jason: we we talked a little bit about when or I talked about when this happens. I always in my like live classes, I always tell people, you know, after your sort of live presentation with your slide deck,
you know, there there's there's a term sheet and then there's the final documents, which is what I want to talk about next. In due diligence, confirmatory due diligence from the investor, they're going to do some before the term sheet. They're going to do some, you know, after the term sheet and before the legal documentation and how it actually rolls out and happens timing wise.
It really depends on the investor, depends on whether it's an angel round or a VC round or growth equity rounds. Um, but you can expect certain things to happen and they're going to happen between the time that they actually get interested and those legal documents are signed and delivered.
There's just certain things that we know are going to happen and that's why I always tell people prepare for them when you're preparing your pitch materials.
But let's talk a little bit about what are those legal documents that you actually have right that get signed right before that wire gets sent to hit your bank account. You know what for an angel round? What will the corporate documents look like?
Aaron: Yeah, absolutely. So, you know, with a lot of this, again, you want to have like the the basics buttoned up well in advance and it's sitting in the data room because, you know, there's a lot of there's a lot of pieces that are moving when you're out raising capital and you want to be focused on the investors, their questions, and helping them get excited about the business, not putting together your data room.
Get that thing set up ahead of time with who owns what, you know, all the documents there. uh because what you're going to find you're moving into is negotiating the terms of either the um the term sheet and then into the definitive docs once you've agreed on the basics under the term sheet.
A lot of times at this kind of level I think we'll be looking at a a safe round simple agreement for future equity which is probably the simplest lowest friction way of getting cash into a company. It's an agreement to issue stock uh in the future.
You can have a few different flavors of those, but they're on kind of an agreed form and tend and folks tend to say we'll stick to the form and not negotiate a lot of the kind of side pieces of this, which means you can keep legal fees down and keep more money coming into the business.
Um, another very common approach is convertible debt. Uh, a lot of the same, you know, terms and features as are in the safe, but get negotiated a little bit more. Um, and give people a little bit more seniority in terms of their rights before the conversion happens.
Aaron: And so one thing um you know obviously my background is growth equity what I've done for 20 years later than venture capital right so at that stage we are putting a value when we invest we're we're valuing the company right we're putting a value an enterprise value and out of that is derived an equity value on the company.
One thing that's important to note uh for an angel round what you're talking about both the safe and the convertible note um they sort of kick the can down the road on the actual valuation right so the convertible note for example says uh you know that the the note has a right to convert into equity in the next round that's actually priced meaning the investor comes in and does a valuation and there's a cap on that round.
I don't want to get into a ton of term sheet discussions and things like that, but the idea of that is for early stage companies, it does take some of the kind of um legal time and documentation. It keeps it lower because for an angel round, they're not actually putting a specific price on the rounds.
But another thing I want to point out for people who are watching this video, love the the idea we talked about earlier where there where you're going to give me the exact location on your website where they can get those free documents, some forms, but anytime you are negotiating a term sheet and anytime you are signing a legal document, whether whatever the legal document is, but especially uh any sort of growth capital round, you need to be working with a lawyer.
you you have to have that lawyer by your side helping you negotiate those terms because you could give away a lot of value and not know about it. Um and then B before you sign those final documents um you need to have the help of a lawyer, not not just the the free resources that are on your website. So I just want to be super clear on both on both of those things for people kind of before we we move forward.
Jason: that's a great point around when to bring us in, right? you know when is it worthwhile to do so I think one of the stages is in the very early stage when you're setting up the company hey how should I be thinking about the what the vesting of my founders will look like why do I have to you know be subject to risk of forfeiting all my shares for four years um what about acceleration a lot of questions pop up at the foundation side and it's it's worth having that conversation with somebody who's been through this multiple times and can help guide that conversation and get you guys to a comfortable position with um you know for everybody involved.
Um then you know go work on the business, focus on that. You don't need a lot of legal resource at that time. If there's a you know a a consultant or a big hire that you're planning on making, give us a buzz and say, "Hey, I'm planning on doing this. Is the form that I got from the website a good one for this or should you send me a different form for this particular one?"
Um whenever you're issuing additional equity to people, reach out to us. million ways to mess it up.
Um, and then you know really the critical time to bring us back again like you said Jason is around the uh the time of a financing event and we can help explain the terms make sure that you know you understand what it'll mean for the cap table, what it'll mean for control rights over the business.
Hopefully it's a nice clean easy round. Sometimes there's more rights that get pulled in and you know you want to make sure you understand them before signing up to anything.
Yeah, for early stage founders and CEOs, especially the ones that it's their first goaround, I like to keep it really simple. I'm like, before your signature goes on the paper, whether that's a term sheet or any of these final docks or whether you're raising a small business loan, you need to work with a lawyer.
A to protect yourself, B to make sure you're not giving away, you know, more than you need to be to an equity investor who's going to own a piece of your business.
Jason: Intellectual property, you talked about it earlier. Let's just circle back on that really quickly.
Why are investors so interested in it? Why do they sort of obsessed with it? Especially if they're investing in a technology company.
Aaron: Yeah, for technology companies, that's that's what it is, right? You're selling an idea. You're selling a a thing that exists uh in um on a SAS platform. It's all about the intellectual property and the thing that you have designed and built and the company's ability to operate that, commercialize it.
And for most companies in the space I work with, either have an IPO with it, um, bring in public investors or sell to somebody else. And that company that goes ahead and buys in the future is going to want to know that they own everything that they think that they just bought without having to deal with third party claims to the technology or without infringing the rights of others.
Jason: Okay. Yeah, it's uh I mean that was a loaded question. you know, it's it's certainly super important for um for investors who are investing in tech companies and it and it always comes up and that's an area where you really do need that professional review.
Um I know we haven't talked a lot about sort of a couple topics, commercial contracts, customer relationships, there's going to be less of that for early stage companies, but maybe touch on that quickly. And then also the topic of you know regulatory compliance issues and things like that. If there's anything that we haven't talked about already that you think is important.
Aaron: Yeah, I think with the um you know on the kind of the commercial contract side of things like you said it's you know becomes more and more of an issue as you do more work um and engage with more third parties to help the business.
um you know in those early stages it's it's looking for material customer contracts if you have any suppliers and vendors that are helping out um places where you might have had to negotiate everybody knows what Amazon's AWS terms are um until you become bigger and are negotiating with them uh but it's you know the ones that you may have terms you may have negotiated with a developer or another company that's helping you uh build a component that's going into your uh technology stack.
Uh those kinds of things, taking a look, making sure there's no rights in there that could cause a problem for the company down the road.
Um same thing with resellers and distribution rights. Have you granted exclusivity to somebody for your US uh market? um that can you know limit the upside potential for the business in a way or that the um investor would want to know about and make sure they're comfortable with.
Um for you know on the regulatory kind of side of things for most techbased companies the early stage piece is having a terms of service on your website. Um, and for anybody that's, you know, clickth through agreement type style, um, especially if it's, you know, BTOC type business, um, where there's just, you know, more that needs to be, uh, laid out for who has what rights involved.
Jason: Okay. And then we talked a little bit about sort of preparing your virtual data room, right? There's a lot of platforms. people can find those, but maybe I don't know platforms the top one or two or three or whatever you see used. Uh and then what happens if an investor finds something in legal due diligence?
Aaron: Yeah, absolutely. So, um there's a lot of great platforms out there. We see Carta being used a lot and so Carta is an online uh equity management platform.
So, they do a lot more than just be a data room to hold docs. They are a great resource actually for uh managing your cap table uh keeping everybody's equity straight, understanding how much is vested and being able to help model future rounds of investment.
Uh they also have a data room function built in there. A similar uh service provider is uh shoe box.
Um both of those do similar types of work.
Um and then on the you know the early stage you know angel kind of round even just having a Dropbox or a Box.com uh folder that you keep with private permissions.
Um and then share readonly access to folks as needed on a go forward basis uh can be enough to get that starting point.
Jason: And then the the other question was just sort of what happens if an investor uncovers something right? um maybe just share a story or two of a of a minor issue and a major issue that you've seen. So,
Aaron: yeah, I mean, look, the number one thing is is try and get ahead of these things ahead of time and talk to the the lawyer that you've engaged to figure out what the solution is.
That way, even if you haven't fixed the problem yet, you've got the answer to the question that's coming and you have a plan and they can say, "Okay, great. Even though this isn't buttoned up, this is the way to go."
um you you see this kind of thing pop up all the time where there's a an ex-founder whenever we see somebody has left the one of the first questions we ask is you know who's who is involved in the founding of the company are they all still there oh this person left okay what was you know were the terms good yeah everything's good okay well you know do they own anything at the company no or maybe they own a little bit but not that much and we dig into that we want to know and make sure okay show us you know what was the issuance um document around how much they were promised uh and how much they actually received uh when they left the company.
what was done to make sure that their stock went back to the company so that you understand what the cap table looks like.
Because what happens in those circumstances is when the person finds out about uh the new round of financing that's going on, one of the first questions is always, ah, you know, how do I get my piece of of that?
um and they have leverage at that point to get cash, get stock, whatever it may be to make the problem go away so that you can get the investor in the door.
And the extra equity that you have to issue um comes out of the founders's pockets usually
um or it it results in a a reduction to the valuation of the company by the amount of cash that has to go out um or a similar kind of mechanic.
And so it hits directly to the founders when that type of thing happens.
Uh causes more cost in terms of having to have the lawyers go and paper up a solution to it and answer questions about it.
Um so one of those try and get ahead of it ahead of time with good corporate hygiene.
Uh try and fix problems before you bring in investors in their council and have a plan to remediate.
Jason: Great. Well, this is we've covered a lot of ground here. Um, any closing thoughts or messages? I mean, I tell people you a lot of this is sort of reducing friction, right?
You don't if you can reduce friction between the time that that investor gets interested um and the actual signing of those legal documents. You want to try to do that.
You know, you want to prepare for that in advance because you don't they'll there something is going to pop up as hard as you try, the investor is going to find something going to dig into it.
But if you don't do this stuff in advance, you're going to you're creating a lot of friction that's going to make your chances of actually closing, right?
When you think about those 50% of the shark deals that close versus don't close, right?
Anything you can do to reduce friction puts you in the 50% that close category.
But in terms of just kind of wrap up thoughts you have, anything we didn't touch on, anything you think is important takeaways for our audience?
Aaron: I think you're spot on, Jason. It's reducing that friction.
Let everybody focus on the fantastic things that you've been doing on the business and have as few distractions to that as possible.
It's having great cover hydrant isn't going to get you funded, but uh that's that's the idea. that's the platform in the business that you're building, but it certainly can be a barrier to having that happen and can take an interested investor and have them walk and go a different direction with their uh potential investment.
Um it's it's cheaper to get it right the first time than it is to fix it later on.
Uh it's, you know, it's it's all too easy to say that's not important. I'll I'll get this papered up later on.
It's always more expensive to do that than it is to get it right the first time around with the right help.
Jason: And I talk a lot about how, you know, people get discouraged, right?
It's hard to, you know, VC firms look at over a hundred companies for each one they invest in. And the average angel group looks at at least 40 companies for each one they invest in.
But some of it's just finding the right fit, right?
I uh there's sort of one of the we talk about a read me pitch and investment summary.
And one of the hidden advantages of that is, you know, if I get an investment summary, something that's well written, a readmeoriented pitch that's easy to scan and understand, and you know, it's for something that's clearly not in the realm of what I do, right?
But I have a way of making an introduction to some another investor who I know might be a better fit, right?
That that investment summary format designed to be emailed to that other investor is hugely valuable because now I can make a warm intro.
warm intros and referrals get more attention, they're more likely to be closed.
So, I talk a lot about how it's some of it's just finding the right fit.
Not every investor is going to want to invest in your company, but when you do find that fit, you get somebody interested.
You don't want to lose them in the due diligence process because you didn't do the work.
And that's really, I think, you've given us some great insights um into how to prepare and how to prevent that.
We want to put yourself in the 50% of the shark using that metaphor, the 50% of the shark investments that actually close.
And this corporate hygiene piece is um it's critical uh it's a critical portion of it.
There'll be a lot of business due diligence things that the founders and CEOs can handle themselves, but um this corporate hygiene piece, which is really part of the broader legal due diligence piece, um is something that they have to do and have to be prepared for.
So, we really appreciate your time. Thanks for asking answering all these questions and um we'll uh we'll include your website, the exact link to where founders can get documents and I'll probably if it's okay with you just include your contact information on the closing slide.
So, folks want to reach out to you directly, they can.
Aaron: That sounds great. Yeah, founders workbench and I'll uh I'll send you the link, Jason.
Thanks so much for having me on today. I really appreciate it. It's been great chatting.
Jason: Likewise. Thanks, Aaron.
