Before the raise: Tips to get your Canadian startup investor-ready

Pitch and the funds will come, right? Hopefully! But there’s a lot that comes between delivering the pitch ‎and receiving the cheque.

After your initial friends and family round, and perhaps even after an angel investment or two, your next ‎step will likely come in the form of investment from established strategic investors, venture capital firms, ‎private equity, angel syndicates or similar professional investor groups. With a little bit of advanced preparation, you can get your startup ready for ‎investor scrutiny, helping you save time and maintain value as you negotiate with investors.‎

Preparing for this outside ‎investment round is important, as this next round of investors will dig in deeper to diligence and expect ‎founders to have cleaned up their companies in previous rounds. Through our work as both company ‎and investor counsel, we’ve seen many companies dive into an outside round before they are ready. ‎Unfortunately, failing to take the time to properly prepare can lead to a longer, bumpier transaction ‎period and ultimately an investment on terms that are far less company-friendly than the founders ‎expected after the original term sheet was signed.

Read on a for a few tips to get your Canadian startup ready for ‎outside investment from a legal perspective. ‎

‎Keep it clean; keep it simple

One goal in keeping an investors’ interest and favour is to keep them focused on the business and the ‎problem you are solving or the solution you are providing. A messy share structure, incomplete ‎corporate records, and strange shareholder provisions disrupt this focus and instead bring investors’ ‎attention to what may be required to clean up the company (with their funds).‎

Most startup investors expect to be coming into a company with one class of common shares and ‎perhaps a class of preferred shares, if there has already been a priced round. There can be very good ‎reasons for a second class of non voting shares (often used for employee stock option plans), though ‎this tends to be more common in Canada, and less common in the US. The simpler and more familiar ‎your share structure, including the number of shares actually issued and the size of any reserved option ‎pool, the more accustomed the investor and their counsel will be. This will allow them to focus on your ‎business and projections, rather than on the fact that you have Class H redeemable, retractable, voting, ‎preferred shares issued that may, in some circumstance, sit in preference to their to-be created series.

There are reasons to have a “funky” share structure, but more often than not the reason ends up being ‎because you engaged an advisor unfamiliar with startups and the typical fund raising path, who then had ‎you set up 18 classes of shares like a small family run business. This can all be cleaned up, but it is ‎easier and cheaper to do it before you have other shareholders who require input and  sign-off. ‎Moreover, waiting to clean up a complicated or unnecessary share structure until a deal is on the table ‎can slow down funding, as many investors will request this type of clean up be completed before they ‎fund. ‎

Consider intellectual property (IP) ownership ‎

If IP is a major asset in your company, you will need to take steps to protect it and ensure that the company ‎owns all of it. This will come up as one of the first and stickiest questions in an investors’ due diligence, ‎which is fair if IP is a large portion of the value ascribed to the business. When taking stock of IP ‎ownership and protection, there are a number of protections to consider. The more obvious forms of IP ‎protection may be filing trademark applications, developing and filing patent claims and confirming trade ‎secrets are protected under NDAs.

Less obvious and more often overlooked, even though it’s just as important, is ensuring that all IP ‎created by anyone who has touched a material or early part of the business has been properly assigned ‎to, and moral rights waived in favour of the company. While current employees and contractors may be ‎top of mind here, you will also need to consider agreements and/or IP assignments from the initial ‎founders or former key employees who may have since left the company. It is never too early to track ‎these folks down now rather than  hold up a future closing in order to find a former founder, who has since ‎moved on,  to convince them to sign a confirmatory assignment of IP.‎‎

Prepare early for due diligence ‎

Get your (legal) ducks in a row before you go out to share a data room. It is common to see clients assume that once they have incorporated their business online, they have completed the process. This is a ‎fair assumption, as the online filing system (and many of the available third-party services) are not ‎particularly clear in this respect. In reality, there are often a few more steps required to complete your company’s ‎corporate records. These include: resolutions appointing directors, setting a financial year end, waiving a ‎requirement for annual financials, actually issuing shares, and creating central securities registers and ‎registers of directors and officers. These are the bare minimum corporate records an investor will expect ‎to see in a legal section of a data room. Failing to have these threshold items leaves founders on their ‎heels responding to the simplest of requests rather than focusing investors on their product or service.

If you are further along and have a product or service launched, start compiling your standard form ‎documents, as well as all fully executed customer, supplier, and other commercial agreements, ‎statements of work, and licenses. Having a data room from the start specifically organized for investor due diligence ‎ will place the company ahead of the game when investors ask for access, rather than have you ‎scrambling to find where in Google Docs that key customer contract may be.

The right startup lawyer ‎should be able to support you in considering the types of items that should be included. They might even ‎provide a sample diligence list of itemsan investor may initially request. It is also important to consider the company’s confidentiality obligations in this ‎process, including to employees, customers, and other parties. For this reason, it is essential to require ‎an NDA or similar confidentiality provisions (these may be included in some data room platforms) before ‎sharing confidential or protected information with a third party.‎

Plan for timing‎

Raising money takes time and effort. While some investors may be able to move things along as quickly as a ‎matter of weeks, pencil in at least a few months for a full round to be safe. You want to avoid having to ‎ask a soon-to-be investor for additional bridge financing because you assumed a raise would take two ‎weeks and did not plan adequate runway. This could potentially leave you in a less advantageous ‎bargaining position when you need the funds to keep the lights on. Putting your best foot forward also ‎means engaging appropriate legal and financial advisor(s) to assist in your go-to-market plan early to ‎ensure you have the best chance at an efficient and successful financing. ‎

Raising funds from outside investors can be a long and challenging process. Good preparation can help ‎remove impediments which can otherwise slow down, side track or completely overwhelm a potential ‎deal. The above tips are intended to help you prepare for what else you may need to do before polishing ‎that next pitch deck, so that the journey from pitch to payday is smooth sailing.