Early-stage due diligence: the legal documents investors should check

• Bhatti says diligence is there to verify what the company has told you, and a gap usually changes the valuation or the terms rather than killing the deal.
• At pre-seed, legal and tax diligence costs are weighed against checks of perhaps $50,000 to $100,000, so the riskiest investments get the least diligence.
• 500's legal checklist covers the charter and bylaws, board appointments and initial actions, option pool approval, founder stock purchase documents, a detailed cap table, IP assignments and board approval of the investment.
• A missed 83(b) election cannot be fixed later, and options granted without a 409A valuation can leave employees with large tax bills.
• For startups operating abroad, the Delaware C corp must own 100% of the operating entity, or investors may have bought into a shell company.
• Founders get faster responses when their document names match the investor's diligence checklist.

The cap table a founder sends over binds nobody, Amit Bhatti tells an audience of angels and new fund managers. What counts are the legal documents that issue the stock or the options, and the board consents behind them (around 25:47). Bhatti was US corporate counsel at 500 Startups, now 500 Global, where he supervised diligence on the accelerator's investments. Before that he was an attorney at Wilson Sonsini, so he has seen diligence from both sides of the table, reviewing it for investors and producing it for companies.

“You're doing it to verify the information, your expectations, what you have heard from the company, what the company has told you. It's not to discover every single thing that has ever happened with the company.”

Amit Bhatti, US corporate counsel, 500 Startups

His first point is about purpose. Bhatti says you do diligence to verify what the company has told you, not to discover everything that has ever happened. Nobody expects a startup to be perfect. You want to know you are not taking on more risk than you are aware of. If something turns up, the deal does not have to die: the process has worked, and the finding may affect your valuation or the terms. He says 500 sees incomplete information in 95% of companies, and sometimes adds post-closing covenants asking for a fix within 30 days.

“It's a weird situation where these are the riskiest companies and investments you could make, but you're also necessarily going to do less diligence just because at some point it's not worth it.”

Amit Bhatti, US corporate counsel, 500 Startups

Cost shapes everything at the early stage. Commercial diligence comes first and sits with the investing team, or with the angel. Legal, tax and technical work, such as a code review, is usually outsourced once a term sheet or LOI is signed. It is billed hourly, and Bhatti says those bills add up fast, especially when the data room is a full-on document dump. With a pre-seed check of perhaps fifty or a hundred thousand dollars, nobody wants to spend ten, twenty or thirty percent of it on diligence. So the riskiest investments get the least checking.

“Most issues with diligence you can fix. An 83(b) filing is not something that can be fixed.”

Amit Bhatti, US corporate counsel, 500 Startups

Where the documents live depends on the deal. In M&A, Bhatti says, a virtual data room is password protected and every document is watermarked; early-stage companies typically use a Dropbox or Box folder. Either way, the investor usually has to drive the process, especially with a first-time entrepreneur. His advice is to decide what is important to you, put together a checklist and send it over. Investors following someone else's priced round rely on the lead investor's counsel for the legal work, and make their own commercial calls.

“The cap table itself isn't binding on anyone. The only documents that matter are the actual legal documents that issue the stock or issue the options, or the board consents that are issuing any of these items.”

Amit Bhatti, US corporate counsel, 500 Startups

Early-stage investing is a bet on the team, so that is where Bhatti puts most of the commercial effort. You wouldn't take on a renter without a background check, he says, so background checks and reference calls on founders are completely reasonable. Check that experience is relevant: Google, Facebook and LinkedIn logos on a deck mean little if the roles had nothing to do with the startup. He also weighs commitment, such as whether a founder still working part-time elsewhere will push past a first low-value acquisition offer. On the market, dig into the size assumptions and talk to customers.

Then comes the legal checklist 500 runs on every San Francisco accelerator company (around 18:21). It starts with the certificate of incorporation and bylaws: Bhatti has seen companies authorise a thousand shares and send a cap table with a million issued to four founders. Check that the board was actually appointed, that initial board actions name officers and signatories, and that any option pool was authorised. Founder stock purchase documents matter because of vesting, which in the US needs an 83(b) tax filing within 30 days. Miss it and later investors will not want to pay the founder's tax liability.

Options bring the 409A report. Bhatti's example: a company that sold stock to investors at $1 a share and keeps granting employee options at two cents leaves those employees with 98 cents of income on each share, and a huge tax bill. Infuriate the team that way and it becomes a problem for all parties. IP assignments should cover everyone touching the product, founders included; if a founder built most of the product without assigning it, the founder owns that code, not the company. Read the exclusions page at the back of each assignment, and check that the board approved your own investment.

Bhatti describes a trap he calls possibly unique to 500, which invests worldwide. Founders open a Delaware C corp because they hear US investors need one, but the operating company in the Philippines, Korea or Europe is not 100% owned by it. If that entity holds the IP, the users and the revenue, he says, you have just invested in a shell company. In 500's experience it has never been fraud, just something overlooked. His last point sits in a giant box on the slide: make sure every document is signed. Skip diligence round after round on a hot deal, he warns, and you can end up with something like Theranos (around 33:16).

The Q&A has practical advice for founders building a data room. A VC will usually send a checklist with commercial and legal categories, Bhatti says, and titling your documents to fit it makes everyone's life easier and gets you a quicker turnaround. Asked what kills pre-seed deals, he points to founders who are challenged on an assumption and show no ability to process it and move forward. For cross-border raises he advises a Delaware C corp parent owning 100% of the local operating entity. Asking for access to a startup's analytics, he says, is completely valid.

Early-stage investors can use 500's legal list as a minimum diligence request, and founders can use it as the folder structure for their data room. Signed documents, not the cap table spreadsheet, are what a diligence reviewer will rely on.

0:00 I'd like to introduce again our illustrious speaker Amit Botti he's our resident legal expert at 500 startups he's our us-based corporate counsel where he oversees investments from 500 s flagship funds prior to 500 he was an attorney at ws gr where he represented tech companies across all stages of their life cycle from startup to IPO and he has as well been has a number of VC funds and making investments he's been helping them make those investments as well with that I'm gonna pass it out to him he's gonna explain a little bit more about his experience and why he's such an expert in due diligence and then we'll get started with the webinar thanks again thanks Patrick and load everybody and it's joined joined the webinar glad you could make it this morning or afternoon wherever wherever you happen to be yeah I think Patrick covered the background pretty well there but just to give it a little bit more color you know I've been with 500 for a

1:04 few years now and supervised the diligence process of all of our accelerator investments as well as in my law firm life having spent many many days and nights poring through the diligence both from the investor side and producing the diligence when representing early-stage companies so have seen it from both sides of the table particularly on the legal side will touch will touch briefly on some commercial legal points but will also have an upcoming webinar in the next month focused exclusively on early-stage commercial diligence so with that here today we're gonna try to cover the basics of what due diligence is when you should be doing it what level of due diligence you should be undertaking for an early-stage company some common things you would look at for an early-stage company and how that changes over time so without further ado let's

2:08 jump into these slides [Music] so the first thing we have here is just absolute basics for those that haven't been part of a diligence process before and really I think the most important thing to focus on as you're going through a diligence process too is to remember why you're doing this and you're doing it to verify the information your expectations what you have heard from the company what the company has told you it's not to discover every single thing that has ever happened with the company realistically when you are looking at a start-up you don't expect everything to be perfect but you want to make sure that you're not taking on more risk than you're aware of you want to know that okay if there is a problem I've seen it and I know what it is so it's not just that if you are going through a diligence process and something is not perfect that doesn't mean the deal dies it just means that the process has worked as expected and you've you gained

3:13 some piece of information that should affect your thinking maybe about your valuation or maybe some additional terms you want to add into the deal but it doesn't necessarily have to be a deal killer so when you want when you start going through the diligence process it kind of depends on what type of diligence you're doing obviously you're gonna want to go through a significant amount of commercial diligence to decide whether or not you're gonna offer a company in terms of forward with an investment but necessarily you're not gonna want to spend a lot of money with third parties or undertaking significant legal diligence with your law firm or whoever it might be until you've actually signed a term sheet or an LOI so typically at that point you'll kick off a formal diligence process maybe with it maybe with a third party so moving on to the who portion the commercial diligence is typically coming

4:17 from the investing team if you're at an institutional investor if you're an angel just getting into this that commercial this is gonna fall pretty squarely on yourself or maybe an angel group you're a part of sometimes they're sharing resources and helping each other evaluate from the commercial point of view when you get into legal or tax sometimes technical diligence like a code review or something at that of that sort you would outsource it and I've put those three dollar signs there to indicate that those bills will add up fast typically these things are done hourly and it takes quite a lot of time to pour through you know pages of documents that a company produces as anybody that's seen a data room knows there's a variety of levels of organization sometimes it's just a full-on document dump and then you're then you're just paying somebody to page through you know any number of

5:24 things so so diligence can become a very expensive issue and that that really affects what you do on early stage diligence another important factor on the who is that you're typically relying on the lead investor to do most of the diligence especially for a priced equity round the commercial Dylan's diligence you're gonna make your own choices on whether or not you want to invest in a company but in terms of the actual legal tax and sometimes even technical diligence is things that you might just be following on into around if you're not leading and you're not gonna have necessarily the same level of access but it never hurts to ask so in terms of the where we've got as I mentioned typically you'll have a virtual data room which could be very formal like in an M&A transaction where you know there's password protected and every document is

6:28 water marked to make sure that nobody is sharing the documents appropriately or as we typically see with early-stage companies a Dropbox folder a box folder with just a variety of documents included if there's something that you require that a company hasn't provided you should always feel free to ask it you know especially at the early stages you're generally gonna have to drive the process especially if it's a first time entrepreneur so it's helpful to decide on what's important to you put together a checklist and send that over to the company so they can start producing things that you want to see so talking about what you do want to see there's a variety of areas people normally look at when they're doing due diligence on an early stage startup one is obviously the commercial points you want to see maybe a product demo you want to know what the user experience is you want to understand what their target market how

7:34 large their target market is especially for a early-stage company that that can be one of the most important factors is are they addressing a large enough problem you also want to look into the team and the founders you wouldn't take on a renter in a rental property without doing a background check but many people invest in started I was glad doing the same for the founders so completely reasonable to be doing a back deck or some reference calls about the founders there's technical diligence you could undertake you could go depending on your level of expertise you could review you know get into the bones of the product if the company wants to let you see that you could get into the you absolutely should get into the very basic legal items that the company is providing but you could get into customer contracts and a whole host of issues their financial diligence is going to be very difficult for an early-stage company but once once a company has become revenue

8:41 generating is building towards a series a it's very common to expect to see at least basic financial statements and then beyond that depending on where the company is incorporated and where you are located there could be a significant amount of tax diligence just in determining whether or not the investment is feasible so today we're going to focus mostly on early-stage diligence so by their very nature early-stage companies have almost nothing to go on sometimes they haven't even incorporated at the time you begin talking to a potential deal if they have they generally have very little legal documentation they might have they might not have any any financial statements they're certainly not going to be audited entities any projections that you've gotten from the company on what their financial projections are are realistically not going to be worth much

9:45 more than the paper they're printed on so it a lot of times people when they think about early-stage diligence they fall into immediately questions on how do I evaluate the company how do I put a valuation on the company based on you know a discounted cash flow model or how can I project what the valuation should be based on you know how much revenue they made in the last month or a year it's hard to make any realistic financial analysis based on the data that you have for a very early-stage startup every investor has slight differences to the way that they do it it would be you know false to say that there's one correct there's one correct way to do it because your investment itself an early-stage company is going to be relatively smaller typically maybe fifty a hundred thousand dollars it

10:50 could be slightly larger if the company has is raising more money but but at a pre seed stage it's not going to be a very large check so you're not also going to be very willing to shell out ten twenty thirty percent of that in costs just to do a very thorough due diligence process so it's a it's a weird it's a weird situation where these are the riskiest companies and investments you could make but you're also necessarily going to do less diligence just because at some point it's not worth it so I've picked out a couple areas that's really what we find to be key and focusing on when you're doing diligence for early stage investment and those are you really want to make sure you feel comfortable with the team and you believe in the team so diligence related to that area is absolutely key you really want to make sure that there's the possibility for to grow into

11:55 a large enough company that your early stage investment will make the kind of returns you're looking for so the market and and properly understanding the market assumptions that either the company has given you or what your internally deciding is very important it's very important to understand the base to make sure that the basic legal structure of the company is in place and the reason is the reason I say that is not just because it's been my career but essentially you're only your only rights to anything from this company or coming from the legal documentation so if the legal documentation isn't correct and you made an investment that wasn't approved by the board or something of that nature then maybe your investment wasn't actually properly done and it needs to be redone at a different price with different tax implications it can be a huge issue and I've included IP because depending on the type of business that you're investing in that

12:59 could be a very important early stage discussion as well if it's a it's a biotech or a hardware company where there's going to be a lot of hard IP that would be important to explore at the very early stages as well so I've put together a little list here of some sample commercial diligence items you know particularly in the areas that I mentioned for early-stage companies on the left side of the screen here for for the team and the founders it's extremely common at an early stage to do at least some basic background checks reference calls to either prior you know prior employers you might want to talk to you know other people that have invested in this company whether it's if they've gotten to that point you want to make sure that their experience is relevant to the to the startup that you're investing in if somebody presents you a pitch deck that has you know they worked

14:05 at Google and Facebook and LinkedIn but their roles that those companies had nothing to do with the company or now investing it and do those logos really matter to you so it's important they are understanding really who it is that you're investing in because that's really who you're betting on here especially at such an early stage we see companies pivot all the time from you know when we initially invested they had one idea the founders were smart enough to realize that wasn't what was going to take them forward and they were able to think through the issue and make a pivot that worked so really it's the team that you want to be most confident in the last item under the team have put here is the level of commitment and the reason I included that is is we're often thinking about is the founder that we're investing in committed to this company into this to this idea to see it all the way through you know if somebody is currently still working somewhere else

15:08 part-time on an idea are they really going to want to work on this and and fight there any challenges they get are they really gonna want to take it when they get a first MMA offer at a very low valuation that wouldn't actually bring you a good return are they are they really gonna want to push through that and try to build you know the next unicorn it's important to really think about all those things when you're when you're evaluating the team as far as market diligence goes the first thing on there I would say is reviewing the market size assumptions every pitch deck you know you'll see talks about how large the the addressable market is for for this idea you really want to dig into what those assumptions are and make sure they align with what you think they are you might make your own evaluation of what that target market is you want to understand who their competitors are you want to understand how well they already have or if they're still when trying to find a

16:12 product market fit you want to understand the viability of their sales channels what's the cost of them I would talk to customers if they already have them whether it's a list they provided to you or whether you will and and you should pick and choose you know to get there to get a sense of the real experience of those customers some other items people typically do with early stage companies is a basic demo to understand the user experience of whatever the product is you might want to look into the scalability of what they're doing and understand what's on the product product roadmap often a very early-stage company doesn't have very much built out at all depending on if it's a IP heavy company you might want to understand if they've got any patents in the works what the defense ability of the idea is and you know if it's extremely extremely IP dependent you might want to you might want to get a

17:17 third-party review yet even as early as an early stage investment for financial diligence we already mentioned on an early stage company it's really hard to rely on any objections that they give them to you but if if that's something that you're that you're evaluating when you're making this decision you really want to make sure that the assumptions they're making or sound in your opinion so dig into the model see what they're using see if you agree maybe you made your own and see and ask these questions to the founder going back to something I mentioned earlier if something as you're going through this process doesn't line up with what you expected I think it tells you a lot about about the team and the founders if you discuss it with them and is it a mistake they made that they can learn from is it something where you believe that they you know maybe just don't understand the issue fully I think you can learn a lot through that process and further on the financial diligence

18:21 there's obviously the unit economics that you can drill into early-stage companies sometimes those are kind of still changing where it might not be the most reliable figures so with early-stage companies it's always best to think about things a little bit of a grain of salt so the next slide here is a sample legal due diligence checklist and this is a list that we go through with every single one of our San Francisco accelerator companies so I'll walk through what these items are and and maybe touch on a few comments with why these matter so the first is the certificate of incorporation the bylaws of the company as an investor you want to make sure that really that they have like the right number of shares authorized that you expect there are companies we've seen where you know they've authorized a thousand chairs and they send you over a cap table with you

19:24 know a million shares issued to four different founders you really want that's the basic governing document of the company so you really want to make sure you get a copy of that you want to make sure you see that the board has been appointed you know plenty of times founders want to cut corners on the on the legal which I completely understand it's it's not something where they want to make a heavy investment at the beginning and I'm actually supportive of that but you want to make sure that they're not just casually saying so-and-so is a board member and having them sign and authorize documents that they actually have no authorization to do we also look at the initial board actions of the company making sure that they've appointed officers they have signatories if they've created an option pool you want to make sure that it's been authorized by the board by the stockholders so when people are being issued stock it's actually valid you want to make sure you see the founders stock purchase documents again a lot of

20:28 these are going to be related to stock and ownership because again all of your ownership is going to flow from legal documents as well so the founder stock purchased documents are important because often they have vesting included and when there's vesting for a founder you have to make a tax filing in the u.s. called an A 3 B it's a very you know boring tax and legal point but if it wasn't done in the first 30 days after the stock was purchased it's not something that can be done or fixed later most issues with diligence you can fix an 83 be filing is not something that can be fixed and that can result in a big tax liability to the founder and down the line as your Series A Series B's here you see investors look into the company they're gonna ask about this same issue and they're not going to want to pay for the tax liability that comes to the founder so it's really really important to make sure you identify this

21:32 as early as possible and then start to see what what can be done about it I mentioned before employee option grants you want to make sure that there has been a properly authorized option pool if any options have been issued there's something called a 409a report another tax related point but if any options have been granted it's really important that you ask the company if they have a 409a report this is something that gives employees a safe harbor that when they've been granted options at a certain price that it's determined that it was granted at fair market value if a company doesn't do this and has say sold stock for $1 a share to a bunch of different investors and yet is continuing to give stock option grants to their employees at you know two cents on that same dollar those employees are gonna be looked at as having got 98 cents of income on each share so it

22:37 would make a whole lot of the the team of the company that you're investing in upset if they immediately found out that they have a huge tax bill waiting for them so it's really important that you get that you verify that this is being done correctly otherwise it's an issue that the company is gonna have to start to solve and have to spend money solving so if you're putting money into the company you don't want them spending it on solving legal issues you want them spending it on building the product that you are excited about further on this list we've got a detailed cap table on that we typically ask for them to represent all of the other convertible securities they might have entered into as many of the angel investors that are on the line are probably well familiar with often with these early-stage companies nobody is really selling shares directly they're all raising money on a save for a note or the 500 version of the form just a kiss you really want to make sure you get the

23:39 detailed cap table listing out all of the ownership all of the grants all of the convertible securities the company has entered into then the last two items are the IP assignments / employee agreements these are typically rolled into one document you want to ask for one of these for every employee that the company currently has typically it's only a few people at this stage but it's very very important that all of the people that are actually touching the product or working on you know the basic code or whatever it might be for the product that you're for the company that you're investing in that they've assigned all of that IP to the company that includes the founders if a founder hasn't made that assignment but is built most of the product then that founder technically owns that code themselves not the company and you're investing in the company so you really want to see that all that has been properly assigned [Music]

24:41 then the last point is you want to make sure that there's a board approval of your investment so you know a lot of times investors will just sign on to a note and why are the money and and what have you but you want to make sure that the board of the company has actually approved this especially if you're buying stock directly you want to make sure that all issuances of stock are properly done so some common issues that we see all the time in our legal diligence is we see incomplete information I would say in 95% of companies so circling back to the very first thing we talked about that doesn't mean that we don't do the deal we want to make sure we understand what's missing how it can be fixed and sometimes we might add in post closing covenants asking that the company get a certain thing done in the next 30 days after closing but really you want to identify where the gaps are and what's

25:47 missing I noted especially records of stock ownership that's typically something that you're not gonna close over top of you want to make sure that they're stock ownership and all of the all the cap table is very very clear and backed by documentation so that leads to the next point which is we often see that a company has no cap table or they've got several different back to the envelope type versions of a cap table when you get a cap table from a company and they say oh we've got you know only a million shares outstanding and they're split between me and my founder and you can invest for X percentage of the company the cap table should be backed by documentation so the cap table itself isn't binding on anyone the only documents that matter are the actual legal documents that issue the stock or issue the options - or the board consents that are issuing any of these these items if you see a cap table

26:52 that that doesn't come with any documentation you don't necessarily know if that's actually what the company has done we see missing IP assignments all the time so typically we would have companies get those signed before closing as well especially if it's an important employee if it's say the new executive assistant or the new marketing intern it might be less important than if it's the CTO so that's a case-by-case basis that you might decide okay we can close without someone getting an assignment from every single person but if it's a key person you want to make sure it's there also every IP assignment at the very very back typically has a page for whoever assigning it to list exclusions from that an IP assignment so if you ever see exclusions on an IP assignment you want

27:55 to make sure you understand what those are and that they have nothing to do with the company are investing in otherwise it comes near investing in might not actually have the IP rights to some important piece so touched on this before but shares and options which haven't been granted by the board is something that we we see often if it's just a promise that's been made to the companies that's fine often we see companies say where we've promised options to these people they haven't been issued yet at that point we always advise them please get a 409a valuation before you're issuing these options you could incur a real issue for your employees and like we said with an early stage company the most important thing is the team and if you infuriate your team by giving them huge tax bills because you didn't issue options correctly it would be a problem for all parties the last issue that I have included on the common things that we see is possibly a unique 500 thing but

29:00 something we see more and more often as BC becomes global we often invest in companies that are not us-based we invest all around the world and you'll see that many people always say you need to start with a Delaware C Corp or something of that nature to get VC funding so companies will open a Delaware C Corp you'll be investing in that entity but you really need to make sure that that is actually the parent entity of any other subsidiaries they might have in the countries they're operating in so say for example you have a company based in the Philippines or based in Korea based in Europe if you have an operating entity there that is not actually 100% owned by the Delaware C Corp you know those are two very separate companies and if that's the company with all the IPE and all of the users and all

30:03 the revenue you've kind of just invested in a shell company and in our experience this has never done as a you know as a fraud it's it's just something that's overlooked in the diligence process especially when investing in international companies so would caution you if you're gonna invest in a company that has significant overseas operations to make sure that all the companies are connected and the last huge point in a giant box is making sure that all documents are signed it's it's one thing to get a document that's been produced by the company and see that you know all of the the words on the page look correct but if it's not timed it's it's not it's not relevant and it's not valid so please make sure that everything that you're looking at is signed so the the last point to make here is that the changes as as accompanying rows so so we talked about early stage diligence and honestly we talked about it in enough detail that it

31:07 might be as much diligence as you're gonna do on some of these very early stage companies but as the company grows you know series a and beyond they'll have much much more documentation and you'll see a more intensive diligence process when a company gets to an M&A event or an IPO that diligence process could be weeks long for an IPO I know that I've been a junior associate working on putting together a binder full of verification of all kinds of documents that's actually a requirement at that point and really the cost at that point will also increase so but if you're writing a bigger check taking a larger risk that should be expected and that's that's kind of a known known quantity that you're taking on then some examples of things you might do at that stage that you wouldn't have done for an early-stage company is you might review all the material contracts they have above a certain dollar threshold with customers or vendors or both you'll

32:13 review every stock and option issuance well you won't but the associate at a poor law firm that you're sending to work all night will be doing that and you might you might undertake litigation searches depending on the business therein you might undertake lien searches it could be any number of things and the costs will start adding up so last point to make is the leave investor is generally handling the main diligence effort especially on a price ground but given that there's such high competition for some of these very hot companies there can be a lot of motivation to just get a deal done as quick as possible because there's competing offers or you know getting into a round that's being led by by you know a great VC and you really just want to close and you don't really feel the need to go through anything or do a

33:16 thorough diligence process so when that happens and it just builds and builds and builds upon multiple grounds you can end up in a scenario like the there knows debacle that's that's on the detailed in the book that it's in the image there which I'm sure some people have seen and then got a little scared about but that's all we have in terms of specific content today happy to answer questions for the next 15 minutes or so so I'm gonna jump to the QA slide and invite Patrick back on here and see what you guys are wondering about great thank you so much on it that was incredibly insightful and for the Q&A section if you have not already done so please submit your questions in the Q&A tab at the bottom of the screen I'm

34:20 going to be moderating them unfortunately we most likely will not be able to get to all of them but we're gonna share some contact information should you wish to follow up and now moving on to wowza so many questions just came in so let's see so there were several questions basically that we got before the webinar and I'm seeing right now in the Q&A section about recommended tools that you would recommend for early-stage startups pre-series a to get their documents etc lined up and organized and ready to send to pcs yeah this is a great question I think also tools but the organization is really important I think the basic items that I listed on that sample legal Dean you know you can follow that pretty close and put all even as simple as a Dropbox folder and just make sure

35:28 everything is labeled very typically when a VC is looking into your company they're gonna send over a diligence checklist with you know a commercial category a legal category and a few other points and they'll list what the different items are it can be very annoying but if you just title your documents to fit with their checklist it will make everyone's life a lot easier and if you make everything easier for them it will be you'll get a faster response you'll get a quicker turnaround so I would say organization is is super key when you're when you're responding to that kind of thing that that would be the basic the basic starting point they're great and then in terms of exit strategy we have a question from Fiona doll what would you recommend for due diligence processes and exit strategies and if where should you look for some sort of methodology about doing that so

36:33 I think you know there's not gonna be a perfect answer there if you're trying to think about it it's a strategy or company you might want to look at comparative exits that have been in a similar space that would be the most that would be the most relevant thing that you have but obviously things change you might look at you know how do I Gyo market has gone for four companies of that sort like for biotech companies the IPO market was always has always been fairly strong where's for a long time if you're an enterprise SAS company there was a long gap where there wasn't very much of that so I would say industry comparables would be the first place to start but beyond that you might want to think about well what is this a compatible business with it's just something where there are very active companies and M&A in that area most exits are going to come from M&A and not IPO so just something seemed like a natural M&A target that would be another angle you could look at if you're a VC

37:37 that has particularly close connections to those companies you might have a better understanding of is is this something that would be attractive to an Oracle at Cisco or some of the other really big acquirers out there great and we have two questions that I'm going to link together here one is could you provide a true you don't have to give proper names but a horror story of how not having due diligence really mess something up and then how do diligence could have made a difference in that case so learning by family basically how much time you got yeah I think there's a there's a lot of cases of things like that that we've seen over the years some that we felt that maybe we could have some control over some that are you know a little harder to see I think one that comes to mind is there's a company where there was a bad experience with a certain founder in the past and after

38:44 that person their initial company failed they actually became part of the founding team of a different company and they weren't listed as a founder when we went through all the checks of the company initially it wasn't clear that that person was involved at all we didn't really get into the whole team that they had at the time and then later when that person was involved it became a bigger problem that you know that person had been is forthcoming the first with their first company and that come the new company eventually had similar problems but yeah I think that that's a team issue of you know you might only look at the founder because you don't know who else was working with the company so maybe it's important to understand who the whole team is if you've had certain experiences with certain people we have a few questions about dividing responsibilities between

39:51 legal for legal due diligence between the lead investor and an external lawyer can you clearly define what both of those roles would be due diligence yeah so if you're the lead investor really what you're doing for a priced equity round so like a typical Series A you're going to pass all of that legal diligence pretty much to the law firm or whoever you're using is a for that provider the at that point what you're what you're relying on is for that law firm to surface any issues and come to the investor and say here's what we found how would you like to proceed it could be something very minor where you would say oh this is not an issue at all let's just keep going it could be something where you say okay we see an issue with this stock issuance please get it fixed before we're gonna close this deal it

40:54 could be something where maybe they haven't registered to do business in some state that they're doing business in and you might say hey relatively minor issue and you would change the investment Docs to say please get this done within 30 days but primarily the responsibility to do that is gonna come from the law firm of the lead investor so if you're you know writing a smaller check into that same round you're not typically gonna do any of the legal due diligence there all of that is gonna be done by the lead investors Council the commercial diligence you're still going to make your own evaluations and you know feel free to ask the company any questions to verify your model or whatever it is that you're that you're doing to make your decision on investing in this company but on the legal front is just going to be lead investor counsel great and then quickly kind of based off of that so you always want to pay a law firm to do the due diligence process or who would you pay well the law firm will

42:01 handle the legal side of the due diligence process if you're again this is going to be a function of what stage you're investing in how much you're investing if you're writing a 50k check into a Series A you're not gonna pay a law firm ten to fifteen thousand to spend hours looking at the documents again if you're investing in a very early stage company and you're familiar enough with the basic documents and you see you know the stock issuance is alright the cap table is right you're bullish enough on the the market and you see the other you know institutional investors have been involved you might feel comfortable taking that risk but it's a risk that you take if you think that there might be issues you can find some like more solo practitioners that might do some basic legal diligence for for a lower rate but at that point you know you really want to take cost into account because how much more how much are you spending relative to your

43:07 investment to do that diligence so there's some basic things that I would think investors can get really familiar with so early stage legal diligence doesn't necessarily have to come from a very expensive top-tier law firm but when you start moving into priced later rounds that's typically what would happen and I'd recommend awesome alright so here's a question in your experience what's the biggest killer of precede staged deals precede stage deal [Music] I don't know I think it could be a variety of things I would say if the team is not forthcoming when they're challenged about some of their assumptions if they don't seem like they're understanding or taking feedback

44:10 well or open to any sort of like other points of view or coaching I think that can really hurt an investor's confidence in working it's one thing for somebody to have made a target market that was way too large with some assumption that they might have been slightly mistaken about but when somebody brings it to their attention and they don't show any sort of ability to process that and move forward and reformulate anything I think that can be a real killer for for some people to want to back something because like I said at that stage you're really really investing on the team and if the team doesn't seem like somebody that could adapt or learn from any challenges or understand that they don't necessarily know everything I think that would be that back that I've seen be an issue in the past great and we have quite a few questions focusing on

45:18 international companies cross-border due diligence essentially what would you recommend for someone do from a Canadian startup for example to work with US investors or any country country X with US investors I would say we're more and more investors that are willing to invest in global company from the US I think the easiest way and this is the advice I give to all of our portfolio companies as well is that if you're trying to get us investment the easiest way is to incorporate in a form that will be familiar to them so to have a Delaware c-corporation as the parent company and then that would be the 100% owner of the operational entity wherever you're located whether that's Canada Mexico or anything else I think that puts things in a format for people that people understand and then the investor forces to undertake the diligence in

46:25 those other places but from the perspective of the startup itself by doing things like that you take questions off certain questions or roadblocks off of the table if you I'm not saying it'd be impossible to raise money as a Canadian company in the US without doing that but you open yourself up to a broader pool of potential investors by doing some great I think we have time for maybe two more questions and this one's from someone actually sent in questions beforehand so thanks for that how do you validate your metrics do you ask for access to the analytical platforms that they use so yeah I mean I think that's a completely valid thing to ask for if you're you know these numbers look or how did you achieve this kind of growth can I take a look at what this is I

47:28 think it's completely valid to ask those type of questions you know you should always feel free to ask the questions of the company of things that you're trying to validate or understand if they don't want to share it you know sometimes it could be a very valid reason and they'll tell you why but if they come home and something doesn't feel right then maybe that's a factor in your decision but it never hurts to ask and I think there's completely logical reason why you would ask so here's the company doesn't want to do that you know maybe that tells you a little bit of something but it's different if you're asking like hey can I see all of your code and can I get like a day well we don't really want to share that with every single person that we need with but if you're looking at just like kind of raw raw numbers of their analytics you know I think it's a valid question but that kind of question and

48:33 things of that nature and the commercial diligence is something that we're gonna have another webinar specifically focused entirely on that you'll if you're on this mailing list you probably will get another on the next three weeks setting up that next webinar and you know to everybody that did ask a question to the extent I didn't answer in the same way the it's a little hard with no back and forth in a webinar scenario but please feel free to like send your comes in and happy to and try to give you as much information or guidance as I can thank you so much could you go to the next slide on it yeah great and that is unfortunately all the time we have today there are a bunch of questions that we were unable to get to a lot of them focused on kind of readings that folks can look into about clarifying their due diligence tactics and some other kind of listed

49:37 methodologies about how to do so so maybe we can get back to the group with some options for that we additionally will be sending out a recording of the webinar to all the registered participants so if you missed anything or joined little late feel free to re-watch at your leisure and yeah if you'd like so again I want to mention our venture capital and Lots program if you'd like to learn more about steel flow due diligence and many more topics please check out this upcoming deal camp at Berkeley program it's coming up quickly February 11th to 14th remember to get your application in as soon as possible the window ends I believe this week and we only have a few spots left feel free to reach out to me at Patrick Driscoll at 500 startups calm if you have any questions about deal camp or if you have any clarification questions about the webinar as well and with that on it any other final words nope

50:42 things are ready for joining and hopefully it was helpful and you know happy to get a service of lead source and hopefully send you some good content feature fantastic all right thanks everyone so much and have a great rest of your day night afternoon wherever you may be Thanks