Early stage companies struggle to maintain their legal documents because they generally don’t ascribe much value to them. The truth is, the documents aren’t particularly valuable unless your company is worth something someday. If that happens—which is why you are putting in all of these late nights to build your business in the first place—then shouldn’t you make sure you aren’t throwing dollars away? As your company grows the problems amplify, and you’ll pay more and more to clean up what can be fixed. And not everything can be fixed. If you forgot an acceleration clause for your founder stock, you won’t be getting it. You forgot to file an 83(b), welcome to a costly and unending headache.
Each time you raise institutional funds, the company will go through a due diligence process where your investors’ counsel will dig for errors and risk in your company’s history in order to protect their client’s investment. During due diligence, counsel will ask you for all of your board actions to verify that your equity was granted properly. They will ask for all of your IP Assignment Agreements, to check that your employees and consultants have assigned their IP to the company. Extra time spent in this phase delays your close, distracts your team, and adds risk to the deal. Perceived risk in an exit may lead to setting aside large escrowed amounts to protect the buyer against future claims. This story is all too common.
When counsel finds an error during due diligence, how do they fix missing or incomplete documents? They draft more documents! Let’s say you don’t have all of the signed IP Assignment Agreements. This means you have a hole in your documentation and a question as to whether or not the company validly owns the IP necessary to run (and sell) the business. Counsel will patch this hole by drawing up a new agreement, and someone will have to track down that former employee or consultant—and they may not be willing to sign!
This is just one example of many where, because companies didn’t find a good solution to make paperwork easy, they end up having to pay by the hour for counsel to clean up basic documents. This could be tens of thousands of dollars for your Series A financing. That’s expensive capital wasted. Capital costs money, and dilutes your equity! Your lawyer wants to be your strategic advisor; if you ignore the obligations you can manage yourself they will just be cleaning up your mess.
How should it work? Do it right from day one. The right way to get things done should be the easiest way to get things done. No matter how you do it, it will be cheaper to do it right the first time then to pay a third party to decipher what you were trying to do five years ago.
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Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
Sample scenarios are for illustrative purposes only.
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