A practical look at what legal due diligence really involves, and why preparing early can help businesses move through fundraising without unnecessary delays.
Most founders might think of due diligence as something that happens near the end of a fundraising process: a final formality between agreeing terms and receiving funds. In practice, it is often the stage where deals slow down, valuations are renegotiated, or momentum quietly stalls while a founder gathers documents and addresses issues that could have been dealt with earlier.
Investors are not looking to catch founders out. They are looking to confirm that the business they are about to fund is legally what it appears to be. Understanding what investors are actually checking, and why, is one of the more useful things a founder can do long before a term sheet is on the table.
What Investors Are Actually Checking
Corporate Structure
Corporate structure is usually the starting point because everything else depends on it being sound. Investors will generally want to understand the ownership structure, including whether the cap table accurately reflects who owns what and whether share issuances have been properly documented. They may also look at the company’s corporate history for any unresolved disputes between founders or early shareholders.
A cap table that is incomplete or no longer reflects the current position can create uncertainty in an otherwise strong deal.
Contracts
Contracts come next, with investors looking at whether the business’s revenue and operational stability are supported by sound legal arrangements. This can include reviewing customer contracts for enforceability and renewal risk, checking vendor and supplier agreements for terms that could affect operations, and identifying any change-of-control provisions that may become relevant depending on the structure of the investment.
Intellectual Property
Intellectual property can receive particular attention, especially for technology and product-driven businesses where IP may represent a significant part of the value of the business. Investors may want to establish that the company has the appropriate rights to the IP it relies on and that relevant IP rights have been properly assigned or licensed.
The scope of this review will depend on the nature of the business, but unresolved disputes, unclear ownership or licensing arrangements can create questions around an asset that is central to the investment.
Employment Matters
Employment matters may also form part of the review. Depending on the business and the role of particular employees, investors may consider whether employment arrangements are appropriately documented and whether relevant confidentiality, intellectual property or restraint-of-trade provisions are in place where applicable.
They may also look for any existing employment disputes or contractor arrangements that could create potential liabilities for the business after the investment.
Regulatory and Compliance History
Regulatory and compliance history rounds out the picture, especially for businesses operating across multiple jurisdictions. Investors may want to understand what licences and registrations the business holds, whether it has faced any regulatory action, and whether its compliance arrangements are appropriate for the markets in which it operates.
Preparing for Due Diligence
Legal gaps can arise naturally as a business grows. A share may have been issued at an early stage without the documentation being fully updated, an early contractor may not have completed an IP assignment, or a key commercial agreement may have been negotiated quickly when the priority was getting the deal done. These situations are not necessarily unusual, particularly in an early-stage business. The important consideration is whether they are identified and addressed before they become part of a time-sensitive fundraising process.
This is where ongoing legal housekeeping becomes important. Keeping corporate records up to date, reviewing important contracts before they are signed, and addressing IP ownership or assignment as part of the relevant onboarding or contracting process can help keep the legal foundations of the business aligned with its growth.
Conclusion
Legal due diligence is not designed to be an obstacle. It exists because investors are putting real capital behind a business and need confidence that the legal foundation underneath it will hold. When that groundwork has been maintained as the business grows, due diligence becomes less about reconstructing the past and more about demonstrating the strength of what is already in place.
Before a fundraise begins, the useful question is whether the business is being run in a way that allows it to respond confidently when an investor starts asking questions.
Legal review: Stella Igidi
Please contact us for more information and/or assistance with all legal matters.
