Preparing a startup for its first institutional fundraising round

What do institutional investors check before a first round?

Institutional investors check that the company is properly formed, that it owns what it says it owns and that its ownership is accurately recorded. Legal diligence usually covers corporate records, the cap table, intellectual property, key commercial contracts, employment and contractor arrangements, and any disputes or regulatory issues.

Diligence findings rarely end a deal on their own, but they can slow it down, add conditions to closing or shift negotiating leverage toward the investor. Fixing a missing board consent or an unsigned assignment takes days when the company does it on its own timeline. Under the pressure of a closing date, the same fix can delay funding. Starting a few months before the raise gives time to correct problems calmly.

Why does the cap table need to match the corporate records?

The cap table needs to match the records because investors rely on it to calculate the price per share and their percentage ownership. Every issuance should be backed by a board approval, a signed purchase or grant document and, where required, a record of payment.

Common discrepancies include option grants promised in offer letters but never approved by the board, SAFEs or convertible notes missing from the spreadsheet, founder shares issued without a signed stock purchase agreement and transfers that were never recorded. Reconciling the cap table line by line against the minute book and the signed documents is slow but reliable. Where approvals are missing, the board can often ratify past actions, although the right method depends on the state of incorporation and the specific defect.

How do you confirm the company owns its intellectual property?

You confirm ownership by checking that every person who built the product has signed a written assignment of their rights to the company. That includes founders, employees, contractors and agencies, and it includes work done before the company was incorporated.

Under U.S. copyright law, a contractor generally owns what they create unless there is a signed written transfer, and patent assignments must also be in writing. Founders who wrote code before incorporation should assign it through a technology assignment, often signed at formation. If gaps exist, confirmatory assignments are usually the fix, and they are easier to obtain from people the company is still on good terms with. Check also for open-source components with license terms that could affect how the product is distributed.

What goes in a startup data room?

A startup data room holds the documents an investor's counsel will ask for, organized so they can review them without repeated requests. Building it early also works as a self-audit, because missing documents become obvious once you try to file them. Use a clear folder structure, consistent file names and fully signed versions rather than drafts. Investors notice when documents are missing signatures or dates.

• Certificate of incorporation, bylaws and all board and stockholder consents
• Cap table with every stock, option, SAFE and convertible note document
• Equity incentive plan, grant agreements and any section 83(b) elections
• IP assignments from founders, employees and contractors
• Material customer, supplier and partnership contracts
• Employment agreements, contractor agreements and key policies
• Any pending or threatened claims, and relevant regulatory filings

Which term sheet terms matter besides valuation?

Liquidation preference, board composition, protective provisions and option pool sizing often matter as much to founders as the headline valuation. A liquidation preference decides who gets paid first on a sale. A 1x non-participating preference is common in early rounds, while participating or multiple preferences shift more value to investors in modest exits.

Board composition decides who controls the company day to day. Protective provisions give investors a veto over listed actions, such as issuing new senior stock or selling the company. Option pool sizing matters because a pool created before the investment dilutes existing holders, not the new investor, which effectively lowers the price. Model each term against a few realistic exit scenarios before agreeing to it. A simple spreadsheet that shows what each holder receives at several sale prices often makes the trade-offs clearer than the term sheet itself.

What securities law steps apply to a priced round?

A priced round is a securities offering, so it must either be registered or fit an exemption, and most startup rounds rely on Rule 506 of SEC Regulation D. Rule 506(b) limits general solicitation, while Rule 506(c) permits it if every purchaser is an accredited investor and the company takes reasonable steps to verify that status.

A company relying on Regulation D must file a Form D with the SEC within 15 days after the first sale of securities in the offering. Many states also require a notice filing and fee for Rule 506 offerings, and the requirements vary by state. Counsel for the company usually handles these filings, but founders should know they exist and keep records of who invested and on what basis.

Does a startup need to be a Delaware corporation to raise venture capital?

There is no legal requirement, but many institutional investors prefer to invest in Delaware corporations because standard venture documents are drafted for Delaware law. A company formed as an Illinois corporation or as an LLC can raise, though investors may ask it to convert or reincorporate as a condition of the round.

Conversion is usually manageable, but it has tax, contract and timing consequences, particularly for an LLC. If a priced round is likely within the next year or two, it is worth discussing the entity question with counsel and a tax adviser early rather than during the closing timeline. Some state tax, employment and licensing registrations may also need updating after a change of entity or state, so allow time for those steps as well.

From our practice

In our work, we often find that a company's spreadsheet cap table and its legal records have drifted apart over a couple of years of early hires and convertible notes. None of the gaps are unusual on their own, such as an unapproved option grant or a contractor without an assignment. Finding and correcting them before the first investor call is far less stressful than doing it with a closing date on the calendar.