Australian startups are raising millions of dollars of venture capital funding, with recent high profile raises including Canva raising $50.9 million in January 2018, Hyper Anna raising $16 million in August 2017 and Culture Amp raising $26.4 million in June 2017.
Hundreds of Australian startups are raising smaller amounts in seed and series A capital raising rounds. These are generally private (proprietary limited) companies, so negotiations are behind closed doors. What happens in these investigations and negotiations? What questions will be asked? What documents will your company need?
This article assist to prepare for the due diligence process and key documents to be investor ready.
- A seed capital raise is the company’s first round of capital raising, often from friends and family. A seed round is generally tens or hundreds of thousands. The funds often support market research, development and testing.
- Series A is the next round of funding, often one to several million, from larger investors including family offices and venture capital funds.
- Series B is the next round, larger again, then there may be subsequent rounds, or a sale, or an initial public offering on a stock exchange.
Due diligence process
Due diligence is the investor’s investigation into the startup company, to make an informed decision before committing to the investment.
A venture capital firm, family office or other professional investor will usually have a due diligence checklist setting out the issues to provide information about, and the legal documents to be provided or created, before they will invest.
In the past, due diligence material was often provided in a room with hard copy documents at the investor’s office, called the data room. Now most data rooms are online, through the investor’s own cloud storage, or through a professional data room business to organise and manage the information and due diligence questions and answers.
Due diligence questions
Investors commonly ask about the following:
- Financial information including the company’s financial model, business plan, budget, how the investment proceeds will be used, key suppliers and key cost centres.
- Corporate documentation including for company set up, Constitution, Shareholders Agreement, member and directors’ registers, an ASIC extract showing that information is up to date, member meeting minutes, director meeting minutes and organisational structure.
- Intellectual property including details of all registered trade marks (business name, patents, designs, business names and more), all unregistered trade marks (copyright, methodology, know-how and more), all intellectual property agreements, and details of who developed all intellectual property and who owns it.
- Information technology including license agreements, how software is developed and maintained, how hardware is owned, business continuity plans, security policies, protocols and procedures.
- Financing documentation including details of any loans, overdrafts, leases, mortgages, guarantees and grants.
- Supplier and distribution arrangements including material operational contracts and insurance contracts.
- Regulatory documents including licences required to operate the business.
- Employment/team documents, including an organisational chart of all employees and their role, a list of all employees and their compensation, employment agreements, employment policies, contractors agreements (if any) and details of any employee claims.
Investor ready documents
The key legal documents an investor will expect to see, or that will need to be created before they invest, are:
- Company register documents including share certificates, members’ register, directors’ register, member meeting minutes and director meeting minutes.
- Intellectual property assignment deeds, from everyone who has created IP for the company, to assign the IP to the company.
- Certificates of trade mark registration.
- Shareholders Agreement
- Employment agreements
- Licence to operate the business (if needed in place for launch)
The lead investor or investors will ask questions, which – along with the company’s answers – are an important part of the due diligence process.
What about particularly secret or sensitive information?
If your company has particularly secret or sensitive information, there are ways to provide additional protection, including limited access, access only after completion of the investment, or simply knowing that the information exists as a secret may be sufficient (such as the recipe for KFC chicken).
Due Diligence protection
Once due diligence is complete, the company and investors need a copy of all due diligence materials saved as proof of what was provided. The startup is likely to have made promises about the company, known as warranties. The due diligence material is the startup’s proof that it provided all relevant information to investors.
The key documents for the capital raise itself are a term sheet, a subscription agreement, the resolutions to approve the share issue, share certificates, the capitalisation table and the members’ register.
The investors invest, the company uses the funds as agreed and communicates with the investors as agreed (e.g. monthly directors meetings and quarterly investor reports).
A well-advised and well-prepared company will build a foundation of trust and communication with its investors. This helps parties resolve issues and supports the company to succeed.
About the author
Ursula Hogben is a co-founder and Practice Leader at LegalVision, a multi-award winning legal startup. LegalVision was recently awarded fastest growing law firm in APAC by the Financial Times and ranked 7th in the list of high-growth companies in the Asia-Pacific. Ursula has over 15 years’ experience in corporate law and investment banking in Asia, the United States and Australia. She is a trusted advisor to businesses across Australia for launch and growth including structuring, intellectual property, hiring, scaling and capital raising.