Navigating an investment round or sale is an exhilarating process for founders and investors alike. However, it can also be fraught with complex legal issues that, if not handled properly, can derail a deal before it’s even completed. Many founders, especially those in the tech sector, are eager to close the deal and may overlook critical details, often assuming everything will work out smoothly. Unfortunately, this is rarely the case. In our recent experience, we’ve seen how even small missteps can create significant delays, increased costs, and—worst of all—failed deals.
As experts in the field, we’re here to guide you through the most common pitfalls that could sink your investment round or sale and how you can avoid them with proper legal advice. By identifying and addressing these challenges early, you can avoid headaches, save money, and ensure that your deal goes off without a hitch.
Not all shareholders are ready to consent
It’s easy to assume that once the investors are on board, the deal will proceed smoothly. However, many founders fail to account for the fact that shareholder consent is often required before a deal can close. If all shareholders are not aligned or one or more shareholders drag their feet, it can delay the entire process.
Solution: Incorporate drag-along and tag-along clauses into your shareholder agreements early. These clauses ensure that minority shareholders are compelled to agree to the terms of a sale if the majority shareholders consent, preventing holdouts from derailing the deal. In addition, having a power of attorney in place allows founders to act decisively on behalf of all shareholders, ensuring the deal doesn’t stall.
Unclear responsibility for legal costs
Founders often assume that the company or investors will cover all legal fees associated with an investment round or sale. However, this is not always the case. In transactions involving partial exits, founders may be required to pay legal costs personally, especially if funds are taken out.
Solution: From the outset, clarify who will bear the legal costs in writing. This is particularly important in cases where there may be an exit or distributions to shareholders. By budgeting for these costs upfront, you can avoid unpleasant surprises and ensure your finances are in order when the deal proceeds.
Due diligence delays due to missing or outdated documents
A prolonged due diligence process is a common cause of delays during an investment round or sale. Missing, unsigned, or outdated documents can grind the process to a halt. Investors need reassurance that everything is in order before they commit, and any gaps in the documentation will raise red flags.
Solution: Don’t wait until the due diligence process begins to organize your documents. Work with your legal team to ensure that all company records, IP assignments, contracts, and financial statements are up to date, signed, and ready for review. Proactive legal preparation will help keep things moving smoothly and avoid delays caused by scrambling to gather information at the last minute.
Investor backs out unexpectedly
It’s easy to get excited about a potential deal and focus all your efforts on securing a single investor. However, this is a risky approach—investors can back out for a variety of reasons, leaving your business exposed to uncertainty.
Solution: Never put all your eggs in one basket. Ensure that your deal is non-exclusive and that you have multiple potential investors lined up. In addition, it’s important to keep the business running and growing even while in the midst of negotiations. Should an investor pull out, you’ll be in a stronger position to pivot and secure alternative funding without stalling the growth of your company.
Undisclosed breaches come to light
One of the quickest ways to lose the trust of potential investors is by concealing issues or breaches within your company. Investors will often conduct a thorough review of your business, and if they uncover something you failed to disclose, it can irreparably damage the relationship.
Solution: Full transparency is the key to establishing trust. If there are issues, disclose them early and show investors what steps you’ve taken to resolve them. Investors appreciate honesty, and addressing issues proactively is far more advantageous than waiting for them to be discovered during due diligence.
Overcomplicated cap tables
Cap tables (capitalization tables) are essential for understanding who owns what in your company. However, a complicated cap table with too many layers or unclear equity allocations can create confusion and concern among investors.
Solution: Simplify your cap table as much as possible. Work with your legal advisors to ensure the equity structure is clear and transparent. The simpler and cleaner the cap table, the easier it will be for potential investors to assess the value of your business.
Founders give away too much control
In the rush to close the deal, founders may be tempted to agree to terms that dilute their decision-making power or give up too much control. This can lead to long-term issues where founders are no longer able to steer the company in the direction they envision.
Solution: Be mindful of the long-term impact of any concessions made during negotiations. Whether it’s agreeing to terms that give investors too much influence or diluting your stake in the company, it’s important to strike a balance between raising capital and maintaining control. Work with experienced legal advisors to understand the consequences of each term and make informed decisions.
Failure to address intellectual property (IP) issues
In any investment round or sale, IP can be one of the most scrutinized areas. If intellectual property isn’t fully assigned to the company or there are disputes over ownership, it can stop a deal cold.
Solution: Conduct an IP audit early on to ensure that all intellectual property is properly assigned to the company. Address any ownership disputes and ensure that all patents, trademarks, and copyrights are accounted for and legally protected.
Inadequate warranties and indemnities
Investors expect strong warranties and indemnities to protect them from potential risks. If these aren’t robust enough, it could lead to a failed deal or unwanted liabilities after the sale.
Solution: Work with your legal team to craft warranties and indemnities that are both reasonable and protective of your interests. Ensuring that these terms are clear and comprehensive will help to reassure investors and make your company more attractive during the negotiation phase.
Time pressure compromises quality
In any deal, there is often pressure to meet deadlines. However, rushing the process can lead to oversights and costly mistakes that could affect the deal or its value.
Solution: While timelines are important, don’t compromise quality for speed. Make sure that every step of the process is carefully managed, with sufficient time for review and negotiation. Trust your legal team to ensure no detail is overlooked.
Conclusion: Protect your deal with experienced legal advisors
The path to a successful investment round or sale is filled with potential pitfalls, but with the right legal guidance, these obstacles can be avoided or mitigated. At [Your Law Firm Name], we specialize in helping founders navigate complex investment rounds and sales, ensuring that every deal is structured to meet their goals while minimizing risk.
Our team is recognized by Chambers and Partners as a leading law firm for founders, and we have a proven track record of helping our clients close deals that benefit them long-term. Don’t let these common pitfalls ruin your investment round—contact us today to discuss how we can help you secure a smooth, successful deal.
Let’s talk about how we can make your next investment round or sale seamless.
