This is an opinion piece by Rickard Vernet, investor and legal expert with a long background helping startups. He has a background at Vinge (law firm), Pale blue dot (VC fund) and is now at Bolago (formerly known as StartupTools) where he works with creating legal tools for startups and growth companies. Rickard is also co-founder of NaturaTua, a startup enabling private investments in biodiversity.
TL;DR – keep your eyes on the upside!
Legal and financial DD is usually the one step during the investment process that founders find burdensome and borderline meaningless. So investors (and their advisors) should be crisp and clear on what information they ask for and why.
At the seed stage, investors invest based on the company’s future potential, not on its current assets or customer base. So DD should focus on risks regarding the former, not the latter.
Here are the essential questions that should be asked (and for the founders, why the investor is asking):
- Is the cap table true and robust? Will the investor receive the intended ownership?
- If the cap table is incorrect, the valuation is incorrect. VCs are looking for multiples on invested capital and normally follow strict fund models on ownership in portfolio companies.
- If the cap table is incorrect, the valuation is incorrect. VCs are looking for multiples on invested capital and normally follow strict fund models on ownership in portfolio companies.
- Has the company signed license agreements, exclusivities etc that limits the potential to grow and/or enter new markets? Does the company own and protect its IP?
- Limitations to the commercial strategy of the company, or reliance on IP licensed from third parties and/or with unclear ownership, can severely limit the possibilities for the company to grow and expand into new markets.
- Limitations to the commercial strategy of the company, or reliance on IP licensed from third parties and/or with unclear ownership, can severely limit the possibilities for the company to grow and expand into new markets.
- Are there liabilities or law suits that will materially affect runway?
- If the company needs to raise new money sooner than expected this will have dilution effects on the cap table, and may not fit investors’ fund models.
- If the company needs to raise new money sooner than expected this will have dilution effects on the cap table, and may not fit investors’ fund models.
- Are the founders withholding information? Or are there double agendas (excessive salaries, fundraising fees, related companies involved)?
- Alignment and the ability to build trust is critical to create a working relationship with investors and scale the company.
- Alignment and the ability to build trust is critical to create a working relationship with investors and scale the company.
- Is there fraud or money laundering involved?
- Contrary to what was said above, this one is indeed downside focused. But also quite obvious, no one wants to invest in a non-existing company or be part of a mondey laundering scheme. The investment will be worthless and a potential net negative/legal liability for the investor.
Stay tuned for more insight and perspectives from Rickard in the future.
