12 Things you Need to Know Before Buying that Startup

Beyond the Numbers: Why Financial Records Aren't the Only Important Factor to Consider

If you're considering acquiring or investing in a startup, it's crucial to perform due diligence. Although financials are a critical consideration when investing in a startup, there are several other important factors that should not be overlooked, as they could also impede the startup's growth. Below are some key things to keep in mind when investing in or acquiring a startup:

1. Product.

Verify that the company has a legitimate product and that reported metrics are accurate. Be cautious of companies that have the appearance of a product but no substance. For example, JPMorgan Chase recently sued the founder of a fintech startup it acquired for $175 million, alleging that the founder provided misleading information about the scale and success of the business by creating a long list of fake users. If you're investing in a company, be sure to confirm that the product exists and that any metrics provided are accurate. Additionally, evaluate the quality of the company's technology, including its product or service offering, development process, and technical infrastructure. You should also assess the company's ability to scale its technology and support ongoing innovation

2. Property and Equipment.

Ensure that the company owns all necessary property, products, and equipment, or has a solid lease agreement.

3. Ownership, Liens, and Encumbrances.

Evaluate the shareholders' agreement, including all stock options, stock purchases, and other employee benefit plans and agreements; any public or private commitments related to the company's stock; and any debt arrangements, guarantees, or indemnities between the shareholders and directors. Confirm that the listed owners are indeed the legal owners and that there are no liens or encumbrances on their shares. If there are, consider purchasing the company's assets rather than the shares to avoid liability for any debts owed.

4. Taxes.

Verify that all taxes are up to date and ask about any outstanding tax issues. Failing to accurately report revenue is a criminal offence that could lead to imprisonment and financial penalties.

5. Employment Contracts and Compensation Claims.

Ensure that the employment contracts properly define who owns the intellectual property to work done. Additionally, If you’re investing in a startup, it will be important to ensure that the employees are properly compensated as you will be legally responsible for any compensation claims that arise after you acquire the startup. For example, there was a Twitter trend last year called #horriblebosses highlighting potential claims by former employees against founders of tech startups in Nigeria, if you were to invest in one of such startups, you'd have to settle the claims by those ex-employees and that kind of publicity could be bad for business.

6. Intellectual Property Rights.

If the company owns any patents, copyrights, or trademarks, confirm that they have legal rights to those assets. You should also verify that the company has not infringed on any third-party intellectual property rights.

7. Data Privacy Compliance.

Conduct a data privacy compliance audit to avoid any potential liabilities. Any data privacy breaches could result in significant financial liabilities, which would become your responsibility after you acquire the company.

8. Documents and Contracts.

Review all documents and contracts that bind the company and its shareholders, such as the Articles of Association, Memorandum of Association, non-disclosure agreements, licensing agreements, assignments, partnership or joint venture agreements, and other business contracts. If you are uncomfortable with any terms, try to negotiate amendments.

9. Litigation.

It is important to ensure that you’re aware of any pending or potential litigation against the company and the potential financial liabilities of those claims. If you acquire a company, you become responsible for settling any pending lawsuits.

11. Corporate Governance.

Be aware of any corporate governance lapses, as these could threaten the stability of the company and result in hefty fines from regulators if the company operates in a highly regulated space. For example, In 2019, the Securities and Exchange Commission (SEC) released the result of a two-year forensic audit it had conducted on Oando Plc which revealed some corporate governance lapses. As a result, Oando and some directors were ordered to pay fines amounting to about ₦82 million and ₦147 million, the entire management team was dissolved, its CEO and CFO were each fined ₦91 million and barred from being directors of any public company for five years

12. Indemnity.

Obtain an indemnity from the seller, promising to cover all costs associated with defending any lawsuits and paying all judgments and fees resulting from the seller's failure to disclose or management of the company.

How Professionals can help

To ensure that your investment in a startup is successful, it's crucial to seek the guidance of a lawyer who can help conduct comprehensive due diligence and develop tax-efficient investment strategies. In the end, it's recommended that you consult with both your legal and financial advisors to assess the viability of your investment.

This article was written by Bukola Edgar