Venture Capital Deal Killers for Startups

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies and investors. The information on this page should not be construed as legal advice.

A more appropriate title for this article might be, "What Problems Cannot Be Resolved Upon VC Deals". I say this because a lot of 'clean-up' work occurs with startups, upon financing, that were not represented by an attorney with startup or VC experience in the formation stages. By and large, this work can be accomplished without killing the deal. Entities are often reincorporated in Delaware, changed from LLC's to corporations, and stock restriction agreements are executed. These are all conditions to closing the deal which VC's often deal with in early stage investments. I've seen VC's wait for almost two months, in one instance, although there were particular issues in that transaction which required foreign filings. Some problems, however, will take too long to 'clean up' or they simply cannot be cleaned up. Two that I pay careful attention to are intellectual property title and previous investors' rights.

One of the representations a company will make in standard transaction documents is that they have good title to IP. If the deal is larger than $1 million, the investors might do more than ask for representations to be made. One major problem issue is if any of the founders, employees, or consultants conceived of or developed IP while being employed by another company (or were otherwise under an invention assignment agreement). The company should have invention assignment agreements with anybody working on development. Additionally, if founders have divorced their spouse since creating the property, the community property laws of their state might impact ownership.

With respect to previous investor's rights, too strong of rights might be unappealing to later investors. In convertible note transactions, for example, too large a discount or too low a price cap might mean that the note holders receive more preferred stock than other Series A investors are comfortable with. Investors can agree to retroactively give up rights in order to facilitate the investment, but inexperienced investors (or experienced investors engaged in game theory) might not want to modify their terms.

 

Related Articles: IP Ownership - Pre-Investment Considerations

Representation:  Angel and Venture Capital Representation for Founders Business Formation