5 Things to Remember When Preparing for Legal Due Diligence

The nearer you are to closing an acquisition, the harder it becomes. Once the buzz of finding a buyer wears off, you’re left with a meandering and complicated path to exit. Legal due diligence is where many founders struggle as it’s both dry and laborious. To pass it successfully, you need all the help you can get, and preparation – as ever – is a must. 

You might have considered handling legal due diligence alone. Fair play to you, and we wish you the best of luck. However, you’ll probably realize there simply isn’t enough time to learn what legal due diligence requires, prepare all the documentation, and continue operating and growing your startup. In which case, it might be better to hire an attorney to do it all for you. 

In any case, here’s a summary of what you should prepare in advance. It’s not exhaustive, as every transaction is different, but a framework for what’s to come. Even if you go it alone, preparing the following areas before entering due diligence will save you valuable time during the process and reduce the likelihood of a buyer getting spooked before your deal closes. 

1. Is Your Cap Table Current and Up-to-Date?

Buyers need to review your cap table to see who owns the company. They’ll also want to know whether you have outstanding convertible instruments, such as simple agreements for future equity (SAFEs) or convertible promissory notes that founders commonly issue in return for investment.

Pay special attention to whether an acquisition would trigger the conversion of such instruments as it would mean adding new names and percentages to the cap table. You’d also need to notify the SAFE or note holder to let them know of the conversion. If you’ve not updated your stock ledger in a while, be sure to do so before sharing it with a potential buyer. 

2. Have Equity Grants Been Consented to and Put in Writing?

Documenting equity grants is just as important as sharing the cap table. The buyer will likely perform a cap table tie-off, where they inspect each outstanding cap-table line item and then tie it to consent from the Board of Directors and a written document between the company and the security holder. Any missteps here could tank an acquisition since improper documentation causes headaches later. 

First, it’s a warning sign to the buyer that there might be an undisclosed owner. Second, it raises the possibility of ownership disputes later. And third, it implies the founder might not even have the right to sell the business in the first place. If a founder can’t properly document and evidence the company ownership, where else might they have cut corners or misrepresented the facts?

3. Do You Have Any Outstanding Disputes or Litigation?  

You must disclose outstanding disputes or litigation. The buyer will ask this question, so prepare your answers well in advance of acquisition discussions. If you do have an outstanding dispute or active litigation, it may not be the death of your deal. However, you should be prepared to speak intelligently and candidly regarding the dispute and be able to show a buyer that you are actively steering it towards resolution. 

For example, have you since worked to mitigate the risk that led to the dispute in the first place? Do you have a resolution plan in progress to efficiently resolve your dispute? What effect does the dispute have on your assets, capitalization, or workforce? Do you need to connect your litigation attorneys with the buyer so that they can answer any technical questions? 

No, the buyer probably won’t like outstanding disputes, but you needn’t let it frighten you off acquisition entirely. You need to get to a place where the buyer is comfortable with the dispute, which means you need to do everything possible to mitigate the risk it brings. Or, demonstrate that it won’t affect the material or long-term value of your business.

4. Is Your Intellectual Property Defined and Documented?

Your intellectual property (IP) might be critical to the performance or valuation of your business, and if so, expect the buyer to scrutinize it during legal due diligence. Do you have the correct documents in place to prove your company owns your IP? Do employees, contractors, vendors, or other parties have a claim to any IP? Have you applied for or registered any trademarks or patents? Are all inbound and outbound IP licenses properly documented?

Your service providers should have executed IP assignment agreements that assign all developed IP to your business. An acquisition is frequently the trigger for IP ownership disputes so get your house in order before you negotiate with the buyer. 

5. Is Your Data Room Ready to Share?

Data rooms are virtual spaces to store everything you need to share during an acquisition, such as due diligence documents, financials, asset transfer plans, operation manuals, contracts, employee profiles, and anything else relevant to your acquisition. 

Ask your attorney for a copy of your digital minute book (a compilation of all legal business records), too, as a large chunk of buyer due diligence requests will involve documents that your attorney should have on file in your digital minute book.

The time to populate your data room is now. Include all your corporate documents (your charter, stockholder and board consents, and so on), contracts (especially material ones), financial records, and recent lien searches (if applicable). Waiting until you reach due diligence will delay proceedings while you gather everything together and could discourage the buyer. 

Your attitude and preparedness during the acquisition impact the speed at which it closes. A lack of forethought will likely irritate if not dissuade the buyer completely since you’re effectively making their job harder. At the risk of stating the obvious, remember: your job is to make their job as easy as possible. Make acquiring your company a seamless experience, and don’t leave legal due diligence to chance: hire an attorney from our advisor directory and carve a clear path to exit. 

The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional. 

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