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5 Practical Tips to Prepare for a Successful Venture Capital Financing

Published:

December 14, 2022

Author(s):

• Sophia Mapara
• Robb Baird

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If you’re at the stage in the financing lifecyle where venture capital is the right route to grow your business, here are five tips to help you prepare to secure the investment.

1. Ensure Your Records Are Up To Date

You’ll want to present your company and its management in the best light to prospective investors. To do this, ensure that:

• Your minute book is in order. Hard copy minute books are becoming a thing of the past. A virtual minute book isn’t mandatory, but it’s helpful because it can be viewed from anywhere, making it convenient for you – and for potential investors.
• You’ve made all annual corporate and tax filings, and haven’t, for example, overlooked filing an annual return.
• The company is in good standing with applicable regulators.
• Any shareholder records, including any required register of individuals with significant control, and capitalization tables accurately reflect the company’s current position.
• The list of current directors and officers is up to date.
• Any material corporate actions (typically, those requiring board or shareholder approval) have been recorded through resolutions of the directors and shareholders, as applicable.
• If the company has a stock option plan, it has properly recorded and granted stock options. It’s confusing for investors when a company has promised stock options to its employees or others, but the company hasn’t documented those options. Any stock option grants should be accompanied by a stock option plan, director resolutions approving the grants, signed option agreements, and noted in any capitalization table or option register.

2. Prepare Your Data Room

Prepare for the due diligence process by having all of the information that investors will ask for at your fingertips. This both makes your company and its management look organized, efficient and professional, and saves you time and money during the due diligence process. An effective way to do this is to set up a data room (or have your legal counsel set it up) that includes all of your company’s pertinent information, including:

• Capitalization & Corporate Structure. A list of all issued and outstanding shares, options, convertible securities, warrants or share purchase rights, and details regarding any ownership or control (directly or indirectly) over any other corporation, partnership, trust, joint venture, limited liability company, association or other business entity.
• Governmental Consents & Filings. All consents, approvals, orders or authorizations, and any registrations and qualifications, required to be received by any federal or provincial governmental authority in order for the company to enter into the investment agreement.
• Intellectual Property (IP). Depending on your business, your IP could be very attractive to potential investors, so it’s important to have your IP house in order. Prepare a list of all owned IP and licensed IP, domain names, and registration details, and whether there are any pending or threatened actions, suits, proceedings, contract defaults or infringements, respecting such IP. You’ll include the company’s standard form of IP licence to third parties, and a list of all employees that had access to confidential or proprietary information who haven’t signed an Employee IP Agreement. Importantly, investors will also want to know whether there’s any open source software (OSS) that creates obligations for the company to disclose its owned IP in source code form, license it to make derivative works, or redistribute it at no charge.
• Defaults. Whether the company is violating any instruments (for example, Articles of Incorporation, Bylaws, judgments, notes, mortgages, leases, material agreements, contracts or purchase orders, or regulations), and whether entering into the financing agreement with the investor will put the company in conflict with any such existing agreements or would create any liens on any of its assets.
• Agreements & Actions. A list of any obligations of the company in excess of an amount material to the company’s operations, and any licenses, patents, or rights the company has granted that might limit its exclusive right to develop, market or sell its products, and any indemnifications the company has granted.
• Indebtedness & Liabilities. Details of any dividend payments or distributions, indebtedness for money borrowed or incurred liabilities (other than in the course of ordinary business), loans or advances the company has made to any individual or entity, assets or rights the company sold or disposed of, and whether the company is a guarantor or indemnitor of any indebtedness of any individual or entity.
• Asset Purchases & Amalgamations. Whether the company has, in the past 12 months, engaged in any discussions with any person regarding the sale or exclusive license of substantially all of the company’s assets.
• Certain Transactions. Lists of any agreements, proposals, or understandings between the company and any of its officers, directors, consultants, key employees or affiliates.
• Property. Lists of the company’s property and assets, including details of any mortgages, loans, encumbrances, and leases.
• Financial Statements. The company’s recent financial statements, including its balance sheet, income statement, and statement of cash flows, any material liabilities or obligations not set out in the financial statements, and any changes in the company’s assets, liabilities, financial condition, and operating results from that set out in its financial statements.
• Employee Matters. A list of all full-time and part-time employees and any consultants and independent contractors the company has engaged. Also, prepare a list of any employee conflicts, such as employees who might be obligated under a commitment or other agreement, or subject to a judgment, that could conflict with the company’s business. Compile details about whether the company owes money or is in arrears of payments to its employees or contractors, and details about any key employees who might not continue their services with the company, along with details about any terminated employees and their severance packages. Investors will also want to know details about employee benefit plans, labour unions, tax returns and payments, insurance plans, confidentiality and non-solicitation agreements, and so on.
• Other. Lists of all permits and licenses the company might need, its corporate documents, whether the company complies with environmental law and safety laws, and whether it complies with Canada’s Anti-Spam Law (CASL) (or other comparable anti-spam laws that apply to it) and applicable privacy laws (for example, the Digital Privacy Act).

3. Identify Gaps, Risks & Required Consents

You might be subject to a requirement to obtain another’s consent before entering into a financing agreement with investors. Some common examples are Shareholders’ Agreements, previous government grants or loans, and by-laws. Other agreements might require you to disclose the nature of the financing agreement, or limit what you can do with your assets. For example, open-source software (OSS) will be covered by a licence, but not all of which is commercially reasonable – if not careful, you might be required to provide any modifications to the OSS back to the licensor. It’s also helpful to proactively check in with existing shareholders to get a feel for how supportive they will be to a financing so it doesn’t come as a surprise and interrupt the process later on.

4. Negotiate the Term Sheet

If you’ve been presented with a Term Sheet setting out the basic terms and conditions of a proposed investment, be sure to consult with legal counsel experienced in VC financings. They can help walk you through what terms typically are, and are not, negotiable, and advise whether the proposal is up to par with current market practice. It might entail some expense up front but you’ll benefit from having someone navigate the deal with you.

5. Be Flexible & Realistic

Familiarize yourself and be prepared for the changes to the company, its structure, and shareholder rights that are about to happen. Investors will likely want some degree of control over major company decisions, board representation, and will likely require certain investor protections such as anti-dilution rights and rights of first refusal. Existing shareholders might be required to enter into an amended and restated shareholders agreement, and the company and certain existing shareholders might be required to enter into an Investors’ Rights Agreement, a Voting Agreement, or other agreements. And be realistic and flexible based on the market conditions at the time, and the amount of energy you’ll put into finalizing the financing deal. It’s a good idea to start the process at least seven to eight months before you plan to raise funds, ensuring you have enough runway capital to get you past the finish line, and enough time to devote to the investor curation and due diligence process – while simultaneously running your business.

Please contact your McInnes Cooper lawyer or any member of our Emerging & High Growth Companies Team @ McInnes Cooper to discuss how we can help you prepare to secure venture capital investment.

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