YC's Series A Diligence Checklist
blog.ycombinator.com
blog.ycombinator.com
What about the less sophisticated hires? Employees are trusting founders not to screw them over. I'd expect this piece to advise either: a) educating less-sophisticated employees, or b) increasing compensation for all employees that didn't get their equity grants before the term sheet.
> If you have any pending or promised equity grants you haven’t already taken care of before you start your Series A process, do that ASAP.
Huh? Seriously? If someone promises me equity I expect that finalized within weeks. How many companies just have promised equity sitting around without the paperwork being done?
Edit:
Some super good points about board approval. Most of the company's I've worked at have the rules of the options pool voted on by the board but the grants can be given out without board approval (as long as they were the standard new hire grant and nothing unusual). But I can see how if something like that isn't in place it could take a while.
The employment contract guarantees the equity subject to board approval. I'm not quite sure why people are making such a big deal out of this.
> The board agrees all new employees get X options with a 1 year cliff and 4 year vesting without additional approval so long as total options granted does not exceed Y.
The board only needs needs to be involved if X or Y need to be changed.
Having the board bother themselves with every little hire is just ridiculous. They have better things to do. Plus if the options are defined on paper the company can't be accused of favoring certain classes of employees differently.
An employee who fails to receive full compensation can receive free legal help from a range of organizations with very deep pockets. In many situations companies have a significant advantage, but in this case they really don't.
Sure, people and companies may be completely irrational, but competent legal advice will tell them to leave this one alone.
This is just pure dishonesty. I know folks who have said things like this and I A.L.W.A.Y.S. say "Sure for now send me a text message or email until we can get to documents." Sure enough I have never gotten a text or email or anything in writing.
People/companies who are serious will take an action and tell you exactly when (in the next few days) this will be handled and how.
This is so common that it's not even funny.
So on the one hand, every relationship of this kind (and of most kinds) requires trust.
On the other hand, you as an employee really shouldn't just be flat-out trusting your employers about things where you are technically at odds with them. Even if they have no intention of screwing you over, it's not always about them - they may be replaced by new management as the company grows, for one. Or they simply might not know something, for another - what if they're unaware of a certain tax implication around an equity grant, for example? Founders are oftentimes doing this for the first time, and just like most employees, don't necessarily know everything.
You should really make sure you are aware of all issues and implications of the contracts you get into, as much as is feasible.
This is something that founders should pro-actively surface and address ahead of a financing whenever and wherever relevant.
This is something we're working on advising founders to do. We want to do what we can to make sure that employees - no matter how experienced or sophisticated - get treated fairly throughout the life of the company.
My bad for the wording which seems to suggest otherwise.
Edit: We updated the wording as well.
> Edit: We updated the wording as well.
But the updated wording just says "some hires may realize this and you may then have to increase their compensation...". I don't think the problem being flagged was "you're implying that founders should screw over unsophisticated hires, when you should be implying that founders should screw over every hire they can, sophisticated or not".
When I raised it, I was told that's the way it works. "Grants are not finalized until the board meeting." End of story. I was a junior employee at the time and had no leverage because I had already been in the seat for weeks.
Not sharing for sympathy, just to highlight the reality: this can happen, and unless you get both the number of options and strike in writing -- or a commitment to make them equivalent -- there's a decent chance you will be screwed out of what you're promised.
* Any licenses or agreements of any kind with respect to the Company’s or others’ patent, copyright, trade secret or other proprietary rights, proprietary information or technology, including employee confidentiality and proprietary information agreements.
* Any standard forms of agreements used by the Company.
* Any confidentiality and nondisclosure agreements.
* Any consulting contracts.
Consultants: this is one reason why it's often easier to get in the habit of working off your client's paper than trying to get them to accept your own. A lot of startups might not care, and will accept your MSA. But for some of them, accepting a new MSA creates a huge amount of hassle down the road.
How does this work for startups employing their foreign employers as independent contractors? Also, it might be helpful to mandate startups provide documentation how they're adhering to local labor regulations in countries outside of US jurisdiction (especially if you're a US company hiring in Europe; their local labor regulations differ substantially from US labor law).
Also, under Material Agreements, I don't see anything called out for compliance with GDPR for startups expecting to or currently serving users in the EU. Does YC perform diligence in this regard considering the 4% of annual revenue penalty for those in violation of the GDPR?
Very helpful resource, really appreciate YC sharing it.
You’re right that labor laws are different depending on the country. For example - things like mandatory severance or mandatory “notice” periods before letting someone go. Equity grants can also be impacted (some countries effectively make it impossible or very difficult to enforce vesting). These things are usually surfaced in the process of disclosing against the representations you’re required to make in the fundraising docs. They’re less about diligence materials you share.
Re: GDPR - excellent point. It’s something people look at depending on what the company is doing. The checklist asks for the company’s TOS and privacy policy which is one of the starting points. Usually what happens if it’s an issue is that there will be a call or email exchanges with questions. It’s a more case by case inquiry.
What looks like an unnecessary distraction in the early days will save you time and headache later down the line.
You have to file your documents either way, so why not make sure they are already in a format that's ready for due diligence - once an investor or acquirer comes knocking, you basically have most of your data room ready.
When a public company acquired us, in a process very similar to this one that also involved a 6-figure legal review bill, I did not sign a background check release, or even a credit check.
I would be surprised to learn that A round investors routinely do stricter checking than a public company doing a full acquisition.
> I would be surprised to learn that A round investors routinely do stricter checking than a public company doing a full acquisition.
That's easily explained: when doing an acquisition the company is the focus, not the executives. When doing an investment the team that you are effectively partnering with is a very important part of the deal.
Post acquisition a player with a troublesome past that was not disclosed could be easily discarded especially since this would be considered a lack of disclosure, but in an investment scenario where that player (and/or their buddies) holds the majority of the stock that is not so easy.
A public company that acquires a company managed by a felon might have to restate financials or write down part of an acquisition's value, which leaves me wondering about the supposed disparity.
> What kind of investor was this that required background checks?
A fairly large portion of them, with an accent on financial services and health care related affairs as well as two sided marketplaces because of the potential for fraud and money laundering.
> A public company that acquires a company managed by a felon might have to restate financials or write down part of an acquisition's value, which leaves me wondering about the supposed disparity.
Well, whether or not they are a felon isn't as important as whether or not they are currently up to something that is not proper. And that's the first thing a DD tries to find out and a background check could help to flag potentially problematic cases.
If I came across a financial services company run by someone who has already had a fraud charge stick that would definitely result in a mention to the investors and could very well result in a deal not going through.
I'd be surprised to hear of a background check on an A round in the US, unless it involved a particularly unusual investment size or where something very specific threw up a bad red flag. And usually if you can command a massive A round, you're already a known quantity.
In a note/SAFE round, it is much less likely that there will be diligence.
I'm missing a chattel (I hope that's the right term in English) or asset list and in the IP section a list of licenses obtained as well as statements of non-retention by former employees and executives.
Furthermore a statement of compliance with the various applicable laws (retention, privacy and so on) would be very useful, as well as the disclosure of the results of any audits the company has undergone.
Just make sure you keep a record of everything you do officially and get help in legal/accounting in any questionable aspects of your work.
Don't wing anything. Don't be lazy, be super detail-oriented in everything and you'll be okay.
If you're lucky and the deal goes through you get to pay that out of the investment, if you're unlucky and the deal does not go through due to major surprises during the DD then you may end up not being able to raise at all and you'll still bear the costs, if the surprises are due to the company failing to properly disclose stuff early on that they could have reasonably been expected to know about then there is a fair chance they will end up being saddled with the costs of the counterparty.
So much for a private sale of shares. In Pakistan, a proper listing agent can put your company on the stock exchange in under 2 month with most of this time just waiting for permits to arrive through snail mail.
Pakistan is not exactly known as a hotbed for serious start-up activity, clearly the list is US centric.
And that is stunning by itself. This is a reason to think one more time about US business culture. Especially for people repeatedly poking developing countries for dysfunctional bureaucracy.
>Pakistan is not exactly known as a hotbed for serious start-up activity, clearly the list is US centric.
Hmm. You should put this view to doubt. As a former British colony, Pakistan used to have a lot of stock exchanges even in relatively small cities. Most companies being listed there were small and medium businesses while "reel-old-money" big business groups were kept private.
A typical listing just few years ago could've been from an entrepreneur who opened a concrete factory, or a trucker cooperative opening an industrial commodities company all popping no more than 10 to 20m USD a year.
In US, the size of stock market just few years ago was tiny in comparison to the titanic debt market. The ratio of stock to debt market size does look much favourably to me in the "not-a-hotbed-for-serious-startups" Pakistan than in the US
I am not in the US but in Europe and it is much the same here.
> A typical listing just few years ago could've been from an entrepreneur who opened a concrete factory, or a trucker cooperative opening an industrial commodities company all popping no more than 10 to 20m USD a year.
Those are not the kind of companies this is aimed at, a series A as referenced in the article is typically seen as the first serious investment post validation of a concept.
The stock market has very little to do with any of this, most of these companies are - and will remain - privately held, it's a rare exception that one of them will make it to IPO.
Just checked the DD we did on a recent acquisition: 503 rows just in the "checklist", most of which resulted in further documents, statements, references to other systems, explanation, reports, exports from HR systems you name it.
Took a few weeks to compile, even though we had all the information readily accessible. The initial check list was pretty fast to do, but it spawned subsequent requests, discussions, etc which required more documentation to be found and provided etc.
This is a relatively short list for due diligence. While far less dramatic than an engineering fault which could actually kill someone, there have absolutely been extremely expensive incidents in the US which occasioned each item on this list. A portion of them are due to peculiarities of doing business in the United States, which is organized to accomplish many forms of dispute resolution via a professionalized process backstopped by formal legal process, in a fashion which may not be similar to e.g. Pakistan, Japan, most European countries, etc. US companies do frequently generate more legal work than comparable situated companies in other jurisdictions. (There are varieties of work they generate less of, but I'll leave that out of the scope of this comment.)
The legal profession, like all service professions, sometimes recommends work which is not directly in the customer's interests, but in the main it is in the business of decreasing transactional risk. There are material risks involved in investing in a company with undisclosed baggage. Additionally, insisting on a certain level of professionalism helps to shake out other problems, because firms which cannot self-organize to e.g. provide a list of all employees and the paperwork related to them are almost certainly catastrophically managed under the hood. You might not even be creative enough to successfully predict how they're going to blow up, because the theoretical space of mistakes one can make is infinite, but you know that anyone who can't produce a signed copy of an employment agreement on demand is highly unlikely to have a level of risk which is roughly representative of your experience from the distribution of companies which are at least minimally competent.
1) Due diligence requests are made by the investor, not offered by the company. So, it's not about the company's desire for full disclosure or the company's interest in complying with SEC regs. (SEC regs require certain types of disclosures in connection with certain types of placements of securities. The typical VC funding round doesn't require such disclosures.)
2) Yes, lawyers are in the business of decreasing transactional risk. But, relatedly though slightly different, the reason VC lawyer due diligence requests are so long is that lawyers are risk averse. There is no downside to the lawyers to add something to the DD list, but there is certainly a potential cost if they leave something off. And the junior lawyers who deal with these things aren't being paid for creativity or independent judgment...(Not a knock on them. It's just not what junior lawyers are tasked with.)
You write interesting things, but I think that your language is too passive / indirect and full of big words. It'll be easier to understand if it was more simple and direct. Just my two cents.
Now, my theory is the Japanese culture values this style of communication as much as it doesn’t value directness. The reason is there are many avenues to save face when not directly confronted.
You can see this in the way people spoke to each other when disrespect would lead to a dual. And this is still the predominant speech style in US legislature.