As we make our investment decisions basically on the back of a 1 hour conversation, we require that all the startups complete some simple due diligence items before receiving the full amount of investment. We are now starting week 6 of the 440.ng Accelerator Program and, as in past accelerator programs 88mph have run, these items tend to be difficult to chase down. Mostly because many people are starting a business for the first time, and while the frontend of a business, building products and getting them to customers, is vital, having a strong foundation is important to not lose everything you’ve worked so hard for – in conflicts surrounding clients, shareholders, employees, founders, and expenses.
So, for everyone who hasn’t spent time practicing business law and accounting, here are some key documents that say something about the backend of a business, which we have all startups set up and share with us during a due diligence. I’m sure its available elsewhere, but it keeps coming up, so we’ve gathered it all into one place and hope its useful for others too.
Shareholders agreement and Cap Table. All businesses need one. It says something about who owns the business, can say something about what the business does and what assets it owns, makes sure that the shareholders know what to do (and what not to do) with their shares, what rules the business will abide by when making key decisions, and how management will report updates to shareholders. This is a sample that the 440 startups can use if they chose.
Certificate of Incorporation. Many businesses do not need to be a limited liability company, but if you want to have external investors in the business, then thats what you need.
Vesting agreements for all founders. A vesting agreement basically means that founders earn their shares over time. We typically require that period of time to be 4 years. This always causes some discussion. But there are some reasons we demand vesting agreements:
- Shares are basically compensation for time spent in the business. And while all founders initially have the intention to commit many years to the business, the reality is that many things happen along the way and some may leave earlier than others.
- The vesting agreement ensures that founders are compensated for the actual amount of time they invest in the business. And that the business is able to replace founders that leave, without seriously diluting the founders who stay.
- Its also a way of aligning all shareholders interests. Its in the best interests of all that the ones spending the most time in the business are also the ones standing to gain most from doing so.
Here’s an example of a vesting agreement.
Employment contracts. Its important to manage expectations for anyone working in a startup, that includes founders. It protects the business with confidentiality and non-compete clauses. Makes sure everyone understands how much holiday they can take, and whether its paid. And makes sure people are aware of what their termination notice period is. Basically any information that avoids the “But I thought” moment, which leads to unnecessary conflict and uncertainty.
Proof of domain name registration and hosting agreements. In many early-stage startups, the founder has personally registered and paid for these items. Its important that the entity receiving an investment is the entity owning these critical assets of the business.
Budgets and accounts. We ask that they create a simple budget overview of their biggest cost items, cost of products, marketing, cost of operations – especially salary, and any capex costs if their business requires it. All our startups use cloud accounting software and should be able to regularly update and share a simple P&L statement with us. We also request access to their accounts, so we can see what their cash is going towards, and at what rate.
Setting up and updating these items from time to time, will save you a lot of misery down the road.
Note: none of these documents are meant to replace a professional lawyer or legal advice, which may differ amongst jurisdictions. For example, in South Africa, the Articles of Association (the Articles) takes precedence over the Shareholders Agreement (SHA), and therefore the SHA should reflect the Articles for it to be a valid document.