Legal Issues Before Bringing on Investors

Bringing on outside investors can provide the capital and strategic support a business needs to grow. However, raising capital also introduces important legal, financial, and operational considerations. Before bringing on investors, businesses should address key legal issues to reduce risk, streamline investor due diligence, and position the company for long-term success.

Early preparation signals that a company is organized, transparent, and ready for investment. It also helps avoid disputes and delays during the funding process. Below are the primary legal issues businesses should evaluate before seeking outside investment.

Legal Checklist Before Bringing on Investors

Before engaging with investors, companies should confirm that they have addressed the following:

• Established an appropriate corporate structure for raising capital
• Prepared an accurate and complete capitalization table
• Secured ownership of all intellectual property
• Implemented essential legal agreements
• Reviewed regulatory and securities law compliance
• Prepared for investor due diligence

Choosing the Right Corporate Structure for Investors

One of the first issues investors evaluate is whether a company’s legal structure is suitable for raising capital. Businesses typically seek investment as corporations or limited liability companies (LLCs), but the structure must align with the company’s funding strategy and exit goals.

For example, investors anticipating a public offering generally prefer corporate stock rather than LLC membership interests. Conversely, certain investors may favor LLC structures for potential tax advantages, such as pass-through losses.

Companies should also confirm that governance frameworks are clearly defined. This includes:

• Board and management structure
• Voting rights and control provisions
• Approval requirements for significant decisions

In addition, foundational corporate documents should be complete and current, including bylaws, board resolutions, and stock issuance records. Disorganized governance materials can raise concerns during investor due diligence and delay funding.

Founder Equity, Vesting, and Cap Table Accuracy

A clear and accurate capitalization structure is essential before bringing on investors. Investors will closely review the company’s capitalization table (cap table) to understand ownership, dilution risk, and outstanding obligations.

Businesses should ensure that:

• Founder ownership interests are properly documented
• Equity grants to employees, advisors, and consultants are formally approved
• Vesting schedules and repurchase rights are clearly defined
• No informal or undocumented equity promises remain outstanding

Incomplete or inconsistent equity records can create significant legal exposure and undermine investor confidence.

Protecting Intellectual Property Before Raising Capital

For many businesses, intellectual property (IP) represents a substantial portion of enterprise value. Investors will expect confirmation that the company owns or controls all IP necessary to operate its business.

Companies should verify that:

• All IP created by employees and independent contractors has been assigned to the company
• Key trademarks, copyrights, and patents are registered where appropriate with the U.S. Patent and Trademark Office
• Confidential information is protected through nondisclosure agreements and internal controls

Failure to secure IP ownership can create material risks and may jeopardize an investment transaction.

Essential Legal Agreements Before Bringing on Investors

Before raising capital, businesses should confirm that core legal agreements and internal policies are in place. These documents demonstrate operational maturity and help establish clear expectations among stakeholders.

Key agreements typically include:

• Founder agreements addressing ownership and responsibilities
• Employment and independent contractor agreements
• Confidentiality and intellectual property assignment agreements
• Equity incentive or stock option plans

Well-drafted agreements reduce ambiguity and strengthen the company’s position during investor negotiations.

Securities Law and Regulatory Compliance Considerations

Raising capital involves the offer and sale of securities, which is subject to federal and state securities laws. Companies must ensure that any investment offering complies with applicable legal requirements or qualifies for an available exemption, such as a private placement exemption, such as those under Regulation D.

In addition, investors will assess broader regulatory compliance, including:

• Accuracy and completeness of financial statements (preferably audited)
• Timely federal, state, and local tax filings
• Data security practices and privacy compliance, including applicable laws such as the GDPR and CCPA

Identifying and addressing compliance gaps before investor review can prevent delays and reduce legal risk.

Conducting Due Diligence on Investors

Due diligence should be a two-way process. While investors evaluate the business, companies should also assess potential investors to ensure alignment.

Key considerations include:

• Whether the investor’s strategic vision aligns with management’s goals
• The investor’s track record and reputation
• The potential for productive collaboration over time

Misalignment at the outset can lead to governance disputes and operational friction as the company grows.

Frequently Asked Questions

What legal issues should businesses address before bringing on investors?

Businesses should review corporate structure, capitalization, intellectual property ownership, key agreements, and securities law compliance before seeking investment.

Why is a capitalization table important for investors?

A capitalization table provides a detailed view of ownership, dilution, and financial obligations, allowing investors to evaluate risk and make informed decisions. This is important for investors’ understanding of the pre-money and post-money valuations in making their investment decision.

Do startups need to comply with securities laws when raising capital?

Yes. Even private offerings must comply with federal and state securities laws or qualify for an exemption. Failure to do so can result in significant legal consequences.

Conclusion

Addressing legal issues before bringing on investors is critical to a successful capital raise. Companies that proactively organize their corporate structure, equity ownership, intellectual property, and compliance frameworks are better positioned to attract investment and complete transactions efficiently.

Scarinci Hollenbeck advises New York and New Jersey businesses through every stage of the business lifecycle. Our attorneys work closely with startups and development stage companies to achieve the legal footing required to accelerate their growth. For further guidance on founder governance, investor relations, or raising capital, please contact a member of our Corporate Transactions & Business Practice.