What Investors Look at in Legal Due Diligence Around Series A
Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.
In financings around Series A, investors may conduct legal due diligence (legal DD). In seed-stage financings, speed may take priority, but once a company reaches the Series A stage, the legality of its business, share-related matters and contract practices may be examined in depth.
Legal DD is less an investigation intended to cast suspicion on the company than a practical procedure for identifying potential legal risks before an investment. Going through this investigation does not guarantee that all future legal issues will be resolved. However, if the company prepares in advance, it becomes easier to prevent delays in the financing schedule, and question-and-answer sessions with investors proceed more smoothly.
Shares and Corporate Procedures
What is examined in Series A legal DD includes the share issuance procedures and the company's organizational operations. In addition to the articles of incorporation, the certificate of registered matters and the shareholder register, the items examined include records of past issuances of shares for subscription, the design of class shares, and share options such as J-KISS.
If, in past financings, there are gaps in the materials evidencing payment or in the records of decisions by corporate bodies, such as the shareholders' meeting or board of directors, required depending on the company and the content of the issuance, a great deal of time is spent confirming the facts. Where stock options have been issued, the review may extend to the shareholders' meeting resolutions, the content of the allotment agreements and, where tax qualification is intended, consistency with the requirements.
It is not uncommon for related documents to have been scattered as a result of hurrying through procedures in the early founding period. I think it is worthwhile to review the records of past share issuances and share options together before reaching Series A.
Key Contracts and Intellectual Property
The main items examined also include the status of key contracts and the ownership of intellectual property. Investors check whether there are legal problems in the contractual relationships that support the company's revenue and service platform. These include transaction agreements with major customers, service agreements for development and other work, and SaaS terms of use.
In particular, where product development is outsourced, the focus is on whether the company holds the copyright and other rights in the deliverables, or whether it has obtained the licenses necessary for its business. Investors also ask for explanations about assets whose ownership is unclear, such as source code and designs created before incorporation or during a side-job period.
At companies providing AI services, the data used for machine learning, the terms of use of external AI services, the handling of rights in generated outputs and measures to prevent infringement of third-party rights are also examined. In legal practice for startups using generative AI, I feel it is important to be able to explain the basis on which the company may use intellectual property and data.
Labor and Outsourcing
In a Series A review, contractual relationships with officers, employees and contractors are also examined. The company may be asked to submit documents relating to labor management, such as employment contracts, work rules and confidentiality pledges.
At startups, relationships with early members often begin informally, so it tends to be unclear whether the arrangement is employment or outsourcing, how remuneration and actual working arrangements have been organized, and whether work products belong to the company.
Investors are concerned about future claims for unpaid wages and disputes over ownership of intellectual property. I think it is worthwhile to review the written contracts with key members, development contractors, advisors and side-job members before going into Series A.
Personal Information and Terms of Use
In businesses that hold users' information, such as SaaS and AI services, the response to personal information protection and the state of the terms of use are also examined. The review checks whether the privacy policy matches how information is actually obtained and used, and whether, with respect to provision to third parties and transfers to third parties located in foreign countries, the conditions required by law, such as the individual's consent and provision of information, are satisfied.
As for the terms of use, investors look at whether the limitation of liability for damages and the cancellation procedures fit the company's form of service provision. For services that include AI features, a lack of explanation about the policy on handling input data and whether it is used for training can prompt additional questions from investors. In legal DD, the question is not only whether rules exist but whether they match actual operations.
Setting Up the Data Room Early
Preparing an online data room early in anticipation of Series A legal DD makes it easier to share materials. Organize and store the articles of incorporation, registration documents, shareholder register and various contracts in folders by category.
In the course of this organizing work, the company not only puts together materials for disclosure to investors but may also become aware of its own legal issues. It can identify deficiencies in advance, such as lost documents, contracts that have not been updated, gaps between operations and the terms, and missing stock option documents.
At LegalAgent, we view responding to Series A legal DD not merely as dealing with a one-time review, but as an opportunity to put legal operations in order for after the business grows. By moving ahead with reviews early so that the work is not concentrated just before the financing, we help management focus on growing the core business and dealing with investors.
Legal Support Before Series A
For preparing a data room and conducting a legal check in advance, you can consult us through the following pages.
Services connected to this topic