Legal due diligence is a key component of any financing round, especially when institutional investors are involved. It serves to comprehensively analyze a startup from a legal perspective and uncover potential risks. But what does this mean in concrete terms? Which documents need to be disclosed, and how does due diligence impact the investment agreement? In this article, we examine all important aspects of legal due diligence and provide practical tips for optimal preparation.
Why Is Legal Due Diligence Important?
Investors want to understand what they are investing in. Particularly with scalable business models, it is crucial that key rights—especially intellectual property (IP)—are actually owned by the company and not by the founders or external service providers. Faulty or incomplete due diligence can lead to investors withdrawing or imposing stricter contractual conditions.
While legal due diligence in large M&A transactions often influences the investment amount, seed financing rounds primarily focus on transparency and risk minimization. It helps identify potential problems early and address them through appropriate contractual clauses. At the same time, the investor and the founding team fundamentally share the same interest: they want to succeed together. Due diligence is therefore not about one party deceiving the other or assuming a one-sided risk; rather, both are in the same boat. Transparency should thus be a concern for both investors and founders.
The Legal Due Diligence Process
Legal due diligence involves the careful examination of all relevant corporate documents. In a seed financing round, investors typically engage a law firm to prepare a due diligence report. This report summarizes the findings and may have implications for the investment agreement.
A classic example is the transfer of intellectual property rights: if the startup has developed software with the help of an external service provider, investors check whether there is a clear contractual agreement regarding the transfer of copyrights. If not, this can be included as a “closing condition” in the investment agreement, requiring the rights to be transferred before the financing is completed.
Disclosure Systems: Data Room vs. Disclosure Letter
Investors rely on transparency. The investment agreement therefore includes so-called “warranties,” which protect the investor in case discrepancies arise after the financing. There are two main disclosure systems:
- Disclosure via a Data Room: The investor gains access to a structured data room containing all relevant documents. Everything disclosed in the data room is considered known. If an investor later raises concerns about defects, the company can refer to the fact that this information was already available.
- Disclosure Letter or Disclosure Schedules: In this model, deviations or critical information are explicitly listed in a separate document. While this system is standard in the U.S., the data room principle (as described in point 1) is more commonly used in Switzerland.
Which Documents Must Be Disclosed?
To conduct due diligence efficiently, systematic storage of corporate documents is essential. A structured documentation approach not only facilitates the current financing round but also future exits or follow-up investments.
Corporate Documents
- Articles of incorporation
- Commercial register excerpt
- Capital increase documents
- Employee participation plans
- Shareholder agreements
- Bylaws and minutes of general meetings and board meetings
Financial and Tax Documents
- Annual financial statements
- Tax returns and VAT filings
- Loan agreements and convertible loans
- Bank agreements and account statements
Employment Law Documents
- Employment contracts
- Bonus and participation agreements
- Regulations on overtime and notice periods
Intellectual Property and Assets
- Patents, trademarks, and designs (including application and protection status)
- Licensing agreements
- Copyright transfers from employees and service providers
- Domain registrations (often, the company’s domain is still registered to the founder!)
Other Relevant Documents
- Contracts with customers and suppliers
- Ongoing litigation or legal risks
Choosing the Right Data Room
For pre-seed and seed financing rounds, the question arises whether a professional data room is necessary or whether simple solutions like Google Drive or Microsoft Teams suffice. A professional data room offers the advantage of tracking which documents were uploaded when and which investor accessed them. In practice, however, many startups opt for simple cloud solutions with a structured index of stored documents. In any case, maintaining clean documentation and a transparent upload process is crucial.
Conclusion: Transparency Builds Trust
Legal due diligence is an essential part of any seed financing round. It not only provides investors with a solid basis for decision-making but also helps prevent future disputes. By preparing documentation early and in a structured manner, founders can significantly simplify the due diligence process and strengthen investor confidence.
Practical Tips for Founders:
- Systematically organize documents early to avoid delays in the financing process.
- Use disclosure as an advantage: the more transparent the company is, the better risks can be managed.
- Clarify IP rights: special attention should be given to intellectual property—investors expect these to be fully owned by the company.
- Prepare a data room: whether using Google Drive or a professional solution, documents should be well-structured and easily accessible.
By carefully preparing for legal due diligence, founders can not only convince investors but also lay a solid foundation for long-term growth.
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www.konsento.ch - Lex Futura – the law firm for innovative legal support for startups
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