Pre-investment Due Diligence

Before you embark on investing in a potential portfolio client or undertaking an acquisition or asset purchase, you’ll need to take all the necessary steps to make sure that the deal makes sense. This is called “investment due diligence,” and this means more than a simple review of quarterly earnings and profit margins; true, in-depth due diligence can protect your reputation and finances in the event of an unpleasant surprise down the road.

A fundamental flaw in the company’s marketing strategy or business model can be determined by a close review of  corporate records. But make sure you include these other elements in your investigation as well.


Review the company’s history, its reputation, and its corporate structure. This should include a separate review of each entity or division within the organization and a look at the capitalization table. Look for any legal issues from previous investment rounds. Did the company comply with securities rules in issuing securities? What type of investment financing happened in the past? Are there outstanding warrants or other exotic securities that may disrupt the cap table at a later date?.

Founders, Employees and IP

A comprehensive review of the company’s list of founders and employees is essential. Have there been founders who have departed? When and how did they depart? Is there an agreement in place documenting the departure? This is important to examine to avoid claims by aggrieved founders who later claim ownership of the company or its intellectual property

The same is true for employees who have departed. Have all employees and service providers executed confidentiality agreements, and have they assigned over and committed their intellectual property contributions to the company? Were departing employees asked to turn over company property? At a time where many companies are deriving value from their data and intellectual property, ensuring that a target company has guarded its intellectual property is a good sign and gives confidence in management and data security.

Data Security

Relatedly, diligence should examine issues related to regulatory compliance. If the company, its agents, its supplier or its associates take responsibility for managing sensitive customer information, you’ll need to see certifications proving the company’s ability to withstand potential hacks and breaches and report them immediately if and when they happen. These audits are typically conducted by third party data security experts.




Compliance: When Should You Take Action?


After your Series Seed and Series A financing rounds, your new company will be well on its way to gaining a foothold in the marketplace and achieving success. Company long term goals may vary depending on the nature of the business, but at least after these early rounds, founders can typically begin to focus on building the business instead of fundraising.

With that in mind, the completion of Series Seed, and Series A (or B) financing offers the perfect place to pause, reset, and focus on compliance. Take some time at this point to make sure you’ll be ready when auditors come to call, both legal, financial and technical. Here are some things to think about:

Securities compliance -- As part of your Series A and Series B financing, your investors will probably have already requested that the company warrant that it is in compliance with securities laws. Nonetheless, it can sometimes happen that securities compliance is overlooked or simply forgotten, evey by companies with sophisticated counsel. After the rush of the financing, make sure to double check that stock plans and all securities sales fit into a recognized exemption from registration from U.S. securities rules, and comply with any applicable state “Blue Sky” rules. If you intend to take the company public, you will absolutely need to be compliant with all applicable securities rules.

Information controls -- If you are a SaaS provider or otherwise handle confidential information, consider looking into compliance with various information and security standards. For example, SOC 2 compliance may provide a good start in ensuring that sensitive data and information is being handled in a proper manner. Larger customers may require SOC 2 compliance or some other standard.

If your company creates, maintains or uses proprietary information and trade secrets as a key means of success in the marketplace, you should put in place information controls to make sure that you can check your employees’ access to such sensitive information. When employees depart, have them document that they will not take confidential information with them, and you should make sure that they have no more access to company information (such as on cloud drives) after their last day. In the event of a dispute about whether or not trade secrets were taken or misappropriated, this type of compliance is critical in convincing a court that the company took all necessary steps to protect its sensitive confidential information.



Choosing Limited Partners for your Fund

As you seek out appropriate LPs for a new private fund, focus your targeting efforts on LPs that are likely to bring higher investment contributions and fewer problems down the road. You’ll want to look for traits that indicate stability, steadiness, the willingness to weather potential storms and early-stage setbacks, and the ability to clearly communicate needs and expectations. You’ll want patient investors who understand what they’re getting into and you’ll want investors who understand (to at least some extent) where your fund fits in the larger market.

In order to pursue the right LP’s, it helps to understand why investors are drawn to limited partnership structures in the first place. The primary reason: as the name suggests, limited partners cannot typically lose more than they invest. Their losses are controlled, and chances are, your target LPs appreciate this and are not interested in being taken on a wild ride of unlimited risk and reward. Limited partnerships also allow legal teams to adjust the operating terms of the partnership agreement, and many potential partners are attracted to this type of flexibility.

So once you understand the motivations of the LPs who are interested in signing on, how should you choose who is in and who is out?

Choose LPs who are comfortable with your fees and profit share.

Fund fees typically fall between 1.5 and 2.5 percent, and profit share or carried interest typically falls between 15 and 25 percent of total profits. If your fund is large, you have a successful track record as a fund manager, or you have something unique to offer that warrants higher fees and carry, you can command more from LPs. If your fund is small and your experience limited, you will have to keep fees and carry low. In either case, your LPs will need to find satisfaction with your terms based on your track record.

Choose LPs who are comfortable with your investment strategy.

Your LPs should fully understand the philosophy behind your investment decisions and the companies you decide to back. They should believe in both your chosen sector (energy, healthcare, crypto, etc.) and your chosen vetting method. If you lean toward struggling companies with high upside potential, or small startups with bright futures, your LPs should support the general reasoning behind your decisions.

Choose LPs who can contribute at a scale that works for you.

If your management approach is hands on and your staff is small, it may not be worth your time, labor and risk to accept LPs who invest very small amounts. If your LPs are willing to invest more than you can responsibly manage, they may be better off with a much larger fund. In all cases, open communication and a clearly written, fairly negotiated operating agreement will be essential to successful and lasting partnership.



Guidelines for First-Time Fund Managers: An Overview of Fund Structure

If you are a first time fund manager, establishing a private fund is a fairly attainable process. In later articles, we’ll provide a quick overview of the process, starting with a basic description of fund structure. Next week, we’ll list some of the key considerations fund founders should keep in mind while vetting and accepting limited partners.

Private Equity Fund Structure: A Simple Overview

During the earliest stages of fund formation, the primary fund founder and his or her team are known as General Partners, or GPs. General Partners work together to attract and retain commitments from Limited Partners (LPs) who may include high net worth individuals looking for investment opportunities, but can also consist of institutional investors and organizations looking for stable investment vehicles. These types of potential limited partners will most likely consist of pension funds, retirement funds, and insurance companies.

As these institutions—LPs—provide capital, the General Partners choose companies in which to place private investments. Over time, this list of companies will grow into a substantial portfolio.

Before a new Limited Partner begins providing capital, the organization will sign a Limited Partner Agreement (and often a few special considerations listed in a separate document), which will include all the details of liability and accountability on both sides of the table, and will also typically include structural details like the length of a given commitment (for example, ten years), how profits will be divided, and how management fees will be applied.

Before you sign on with your team of General Partners and launch your search for LPs, you’ll need to establish the parameters of your fund and the commitments you’ll make to the LPs who sign agreements with you. For example, you’ll need to establish the focus of the companies in your portfolio. Which industry sectors and geographic regions will you target? What research have you conducted to determine the strength and growth potential of these investments?

You’ll also need to clarify the obligations and liabilities that will make up the details of your LPA, and you’ll need to hone the pitch you present to target LPs. You’ll also need to determine which types of LPs will and won’t work for you. We recommend that you commence this process with a fund term sheet that can be used to suss out commitments. And of course, fundraising on these types of investment vehicles must at all times be compliant with state and federal securities rules.

Tune in next soon—We’ll list some key considerations to keep in mind while selecting potential LPs.



Launching an Investment Fund: Considerations

A growing number of investors are looking for alternatives to standard funds with large scale banks and brokerages, and private equity / private fund firms have long been recognized as a successful asset class. As more investors seek out the returns offered by private investment, the demand for successful and knowledgeable fund managers will only increase. Are you considering launching an investment fund of your own? If so, your goals may be more attainable than you realize. Keep a few considerations in mind.

Research and groundwork

Launching a fund is similar in many ways to launching a small business. Before you can attract the attention and earn the trust of potential investors, you’ll need to toil behind the scenes, putting in the hours of research necessary to differentiate yourself from your competition. In which market sector will you specialize? If you plan to focus on biotech, energy, or healthcare, you’ll need to work these fund goals into a cohesive business strategy. And in order to do this, you’ll need to understand the quirks and prevailing trends of your own marketplace inside and out. Research should be grounded and guided, so before you dive in, create a map for yourself by finding mentors, points of exposure, and focused questions you’ll need to answer.

How will you approach and/or attract target companies?

Some private fund managers want to place their hands on every detail of the companies they target, including strategy and operations. Others just want to clear up debts and build revenue. How will you focus your attention? Since you’ll be targeting companies that are not publicly traded, you may find plenty of ways to help these companies raise capital, but you may also want to focus on helping them build out a better business plan to make them more attractive to a potential acquirer. You’ll also want to make sure you have absolute confidence in the Board of Directors running the company.

You’ll need a strong set of advisors.

No one does everything alone, so in addition to attorneys and accountants, you’ll need to look for and engage industry experts and independent consultants who can help you choose a path forward. Your team should be able to structure defenses and know how to manage information, including in the event of a security breach. Manage risks before they happen.

Details and overhead

In the meantime, just as you would with a small business, you’ll need to rent and furnish an office, hire in-house staff (if you decide to do so), and set up all the nuts and bolts of employment structures, including compensation, payroll, taxes, and insurance benefits.

Don’t let the tasks in front of you hold you back! Every risk is manageable, and every obstacle is surmountable if you have the right people in your corner. Get the answers you need in order to move forward with confidence.



Seed Seed Versus Series A Funding Rounds

In an earlier blog, we discussed the fundamental differences between two different types of funding rounds: Series Seed funding and Series A funding. By definition, seed rounds are private offerings of securities that are targeted toward smaller groups of investors, each of whom will contribute investment in exchange for preferred securities and limited investor protections. In contrast, a Series A usually involves higher levels of investment, classically with institutional investors, who will expect more stringent protections for their higher contributions of capital. 

For most early stage startups, knowing the difference between the two types of rounds only answers half of the important question at hand: Which type of financing is right for your company at this particular moment in time? And what are the stakes involved in making the wrong choice? Here are some things to consider.

Choosing A Series Seed Investment

Our clients usually go with a Seed round when they are very early stage -- perhaps just a year or two into their business. While many investors may be fine with purchasing a convertible note, established angels or early stage VCs may want to directly own some of the business and obtain basic investor protections. If that’s the case, a Seed round makes the most sense. Companies should expect to receive anywhere from $1-$5 million for a Seed, depending on the industry and the company valuation.

Choosing A Series A Round

Series A financing usually requires entrepreneurs to prove to more serious investors that the business is functional, sustainable, and scalable. This may mean proving that a customer base is already in place, a prototype has been created and mass production has been priced out, long term costs have been analyzed, and the company can grow without experiencing risky and expensive stops and starts.

Checks at the Series A stage are larger, because investors see something they like and want the company to use the money to scale. Investors at this stage usually invest somewhere between $2 million to $10 million. Investors will also expect to receive standard investor-side protections, such as a board seat, veto rights over certain business transactions, approval of future funding rounds, and possibly things like a cumulative dividend or drag-along rights.

But choosing a funding option isn’t always as simple as these descriptions would suggest, and while these are general trends, companies have a lot of flexibility in determining the sale of their securities. Sometimes, even for an established business, setting high investor expectations can be risky, and companies deciding between the two types of funding may elect to start with a Seed round so that they can reasonably demand a higher valuation at the Series A and give themselves more breathing room to develop the business. While checks are larger at a Series A, expectations run higher commensurately as well. As market conditions tighten for early stage funding, we have also had several clients turn down Series A funding which they felt was not good for their companies.

The best approach is to make sure that the financing you decide to seek is part of a much larger financing and revenue strategy that looks out to the medium and long term. Don’t look for investment like a pinball in a machine: have a focused, targeted strategy about where you want the business to be in one year, three years, and five years, and execute on that. If and when a funding round seems possible or you get a term sheet, you’ll know where that type of funding fits into that strategy, and what terms will be fair.




Financing Your Idea

If you’re daydreaming about turning your app or industry-disrupting project into a successful business, you’ll find plenty of advice (good and bad) in almost any direction you turn.

But what if you don’t even have a marketing plan or a product prototype in hand just yet? What if you have absolutely nothing on your desk but a clever idea and few supportive teammates who can help you bring your plans to life? In other words, what if you’re so early in the process that you assume potential financiers will laugh and tell you to come back in three years?

Take the first steps.

As with any project, financing a startup can be broken down into a series of manageable steps, and the first step is the easiest: get help. Contact a firm that can walk you through the early stages (the VERY early stages) of the process. And once you’ve done that, your legal counsel can help you set terms and pitch your idea to VCs. The right lawyers can also help you understand how early stage equity financing -- and in particular, Series Seed or Series A financing -- can make or break a venture.

We’ll discuss some of the characteristics and distinctions between classic Series Seed and Series A financing in the next blog, but for now, recognize that seed rounds typically involve the support of up to 15 investors who contribute small amounts—with total financing anywhere from $1-$3 million—and receive some very basic investor protections. Series A financings typically involve higher investment amounts, but also carry with them far more stringent investor rights.

A great Series Seed round can help early stage startups get the capital they need for initial market research and the development of a functional business model. It can then lead directly to a Series A round. Alternatively, a venture may feel prepared to jump directly to a Series A financing, if it is fully prepared to say yes to a large influx of capital and to the investor rights and protections that often accompany that capital (including board seats, cumulative returns, and possibly drag-along rights).

Stay tuned for more detail on this critical early stage decision. In the meantime, recognize that no matter how new and untested your idea might be, it’s never too early to start reaching out for support and putting your plan into action.



Teamwork, Expertise, and the Boutique Law Firm Experience

When a law firm refers to itself as a “boutique”, this usually carries a specific meaning for both the attorneys who join the firm and the clients who retain them. Law firms in this category are typically small, and they’re staffed by teams with a high level of expertise in a focused area of the law.

Some boutique firms (like ours) specialize in intellectual property services. Some focus strictly on immigration, family, or trademark issues. Some focus on a specific type of client, for example a client who wants to move through a complex process like starting a company, transitioning a business across international borders, or launching a commercial real estate enterprise. In many cases, boutique firms work hard to remain small, and they invest a high level of attention in earning client trust within their discipline.

Since boutique firms differentiate themselves based on their narrow focus, their full-service offerings in a specific area, and their high level of targeted experience (especially among senior members), they have much to gain by highlighting distinctions between themselves and “big law”, or large, faceless firms that offer a complete set of generic services and a lower level of expertise.


So the word “boutique” is used as a selling point. But when you’re seeking this kind of service, how do you know that’s what you’re really getting? And when you’re an attorney hoping to sign on with a firm that matches your needs and skill sets, how can you tell you’re on the right track? Here are three signs that the boutique firm you have in your sights can truly deliver on their promise of customized expertise.

1.)    Your firm relies on teamwork.

At truly boutique firms, all the attorneys depend on each other and work together closely. They combine their years of experience and maintain comprehensive brief banks, so all of them—even less experienced members—are ready for almost any imaginable legal situation that might arise in their area.

2.)    New associates have opportunities for growth and a high bar of expectation.

Unlike the “big law” experience, smaller firms can offer direct, targeted and very valuable mentoring opportunities, which means new attorneys can build their knowledge base quickly. They can also dive right in and contribute to written archives and experience banks, especially when their own cases present new or unusual legal challenges. In fact, they aren’t just encouraged to dive in; it’s expected. Over time, those who aren’t carrying their weight tend to leave, while committed experts tend to stay and grow.

3.)    Bureaucracy and competition are both low.

Smaller firms are typically not held back by bureaucratic hassles related to staffing policy, billing details, credit disputes, dress codes, and the other minor hang ups that both streamline and bog down larger firms. On the same note, due to the nature of their client needs, small firms typically collaborate rather than compete with each other. Collegiality, cordiality, and referrals are all common among smaller firms, which works to the benefit of both clients and staff.

Is the boutique experience right for you? Contact us to learn more, and meanwhile, take a look at this video to hear Andrew Dick, CEO of Select Counsel, discuss how small-firm lawyers are working together to build a community (full disclosure, we are part of the Select Counsel network).



Bitcoin: What Now?

During the past few weeks, several high-profile and well-respected voices in investment circles have made public statements disavowing any faith in Bitcoin’s continuing rise and warning investors about what they see as a bubble. Federal Reserve Chair Janet Yellen, during a statement on the Fed’s decision to raise interest rates this week, took a moment to clarify her position on Bitcoin and described the cryptocurrency as a “speculative asset” and an investment with limited material value.

The core message underlying these position statements is more-or-less clear: If you haven’t invested in Bitcoin yet, do so now at your own well-recognized risk.

But what about those who are already committed to the enterprise and aren’t sure what to do next? If you’re like many Bitcoin investors who bought a few fractions of a coin over the summer or during the past year or two, your current portfolio total may be more than you’re used to seeing from a single investment decision. You may be getting genuinely nervous, and if you have no idea what to do with this unrealized small fortune you’re holding, you’re not alone. Here are three things to keep in mind as you move forward into this uncharted territory.

Be careful of investing in other types of coin.

Many Bitcoin investors want to re-invest coin into other cryptocurrencies. In our practice, we have seen an explosion of both securities-based and product-based token offerings (also called ICOs or “initial coin offerings”) to both accredited and unaccredited investors. We have seen a significant amount of companies offering these ICOs with highly mixed compliance with securities rules. Be very careful about investing in other types of coin: in the explosion of ICOs, there are too many companies who are disregarding securities rules and not being honest about what their coin is doing, either by failing to disclose material points, or in outright misrepresentation. Diversifying your coin portfolio is not a bad idea in theory; but you need to be extremely cautious about the new types of coin that are being offered these days, and do extensive diligence on who is offering the coin and why.

Be prepared to get help with your taxes.

Your Bitcoin returns will be taxed as a capital asset, but you’ll have to handle your records yourself—Don’t expect a 1090 form in the mail as you would from a bank or investment firm. Keep track of every one of your purchases and sales, including the date and the price you paid. Use this quick, non-comprehensive overview to estimate your tax obligations, and get specific guidance from your tax advisor.

Revise your long term financial plan.

Maybe you made only a few hundred dollars with your bitcoin investment, or maybe your returns are life changing. We all have a different financial comfort zone, and we all have a different understanding of what feels normal. Every long-term investment plan varies according to the needs, goals and standards of the person behind the plan. If this amount of money feels significant to you, then it’s significant. And if it represents an alteration to your long term goals (like retirement) adjust those goals accordingly. You may also need to deal with the potential headaches and heartaches that might occur if you feel you’ve cashed out too early or too late. Whatever you do: don’t be greedy. Greed and bubbles don’t mix well, and usually the greedy end up being crushed when the bubble pops. Get help from a financial planner or investment manager if you aren’t sure how to proceed on your own. We can help with legal issues, but financial planning is for another expert advisor.





Pitching to Investors: How to Structure Your Friends and Family Round

This is the season when we gather our loved ones around us and think cozy thoughts about our friends and family. We’ll lucky to have them in our lives! They support us during the rough times and they share our joy when things go well…and sometimes they provide the financial backing necessary to get a company off the ground before opening the process to the complexity of institutional investors (or an eventual public offering).

But pitching your business to friends and family may not be as simple—or as cozy and risk-free—as it seems on the surface. Here are a few things to keep in mind as you structure your friends-and-family pitch.


Comply with securities laws

Securities laws are put in place to protect people from making bad investment decisions and being caught up in investment hype or froth that has no sound business case. Before you approach your friends and family for investment, make sure you’ve vetted the investment opportunity by legal counsel. There is no “friends-and-family” exception to the securities laws, and you need to make sure that the deal you’ve put together and its terms are consistent and compliant with both state and federal rules. This is really important! Failure to comply with securities rules can make future financings a lot more difficult and also expose the company to civil and criminal proceedings for breaking securities rules.

Be honest about the offering.

Your potential backers need to be sophisticated enough to understand that they may lose everything they put up. With friends and family, you have to be honest with them and they have to understand that success is absolutely not guaranteed. So-called “accredited investors” are presumed to be sophisticated and able to handle their own financial affairs, but state securities rules may have other tests they use, and your investment deal and offering materials that you prepare for your investors may need to include significant disclosures of risks. Also, be clear about your own risk exposure; if your idea generates income, will you pay them back before paying yourself? If your business struggles, will you accept a level of loss or risk that reflects what you’re asking from them?

Think about the investment opportunity

At the friends and family stage, many early stage ventures elect to offer convertible notes as their first securities offering. But there are other ways to structure investment deals, and some companies forego this traditional path and issue Series Seed stock or other forms of equity to friends and family. With the rise of ICOs, some companies are even considering offering coin to friends and family. Make sure you’ve thought through what the investment opportunity is, and how it will fit into the larger vision for the company.

Invest some sweat equity before making your case.

From a practical perspective, your friends and family will have more confidence in your plans if they’ve seen you at work—literally—for at least a few months before you turn to them for backing. If they recognize your commitment, they’ve heard you talk about your plans for a while, they see you toiling away in the garage, or they can hold and interact with a prototype you’ve designed and built, they’ll gain a clearer sense of your level of determination and business savvy. This is also important from a securities perspective as it helps show the bona fides of the venture. Again, disclosure will be important here, but it’s important to have operating history before you approach friends and family.

Keep your request specific and goal focused.

Instead of simply holding out your hands and letting your investors decide how much to offer, share a clear goal, and explain how you arrived at that number. Break down how this investment will be applied and share the amount you plan to contribute on your own. Make sure your investors understand that there’s a roof on what you’re asking for, but no clear roof on potential returns if your product does well in the marketplace.  This is important both from a practical as well as from a compliance point of view.

Invest in legal support.

At this stage, engaging with an attorney might feel premature, but think of legal guidance as an investment that will pay off quickly if it can clear the path to capital while protecting your relationships with the people you care about the most, and very importantly, ensuring proper compliance with securities rules. Take the right steps at the start, and your family and friends will still be with you as the years pass and your business grows.