The day the wire hits, you are jolted into a position that makes you accountable to a brand new set of stakeholders. To sustain the growth fueled by investments and prepare for a future Series A, you must adopt professional governance and compliance standards that protect the company’s long-term value.
Professionalizing Governance and Fiduciary Duty
Professional capital introduces a permanent layer of accountability to a Board of Directors. Your actions as a leader are now governed by two primary legal duties that dictate how every major corporate decision must be made and documented.
The Duty of Care – This requires that you make business decisions on an informed basis. You can no longer rely on intuition for major strategic pivots; you are expected to perform due diligence, review financial projections, and consult with professional experts before taking significant actions. The Business Judgment Rule protects your decisions only if they result from a deliberate and informed process.
The Duty of Loyalty – You must prioritize the company’s interests over any personal interests. This is a strict prohibition against self-dealing and the misappropriation of corporate opportunities. Any potential conflict—such as hiring a relative or entering into contracts with a business you control—must be disclosed to and approved by disinterested board members.
The Protection of Assets – A breach of these duties can pierce the corporate veil, leading to personal legal liability. To protect your personal assets from shareholder derivative suits, institutional investors typically require the company to purchase Directors and Officers (D&O) Insurance immediately after the round closes.
Board Transparency – Material corporate actions, such as hiring executives, taking on significant debt, or amending the annual budget, now require formal board resolutions. You are expected to maintain corporate formalities by holding regular meetings and providing a Board Deck that includes your financials and key performance indicators.
Removing Roadblocks to Scaling
The capital you have raised is intended to fuel expansion, but this growth triggers mandatory legal and tax milestones. If ignored, these administrative requirements become legal debt that can stall your next round or jeopardize a future acquisition.
IRS Section 409A Valuations – Before you grant stock options to new hires or advisors, the law requires an independent appraisal to set the official strike price. This 409A valuation must be refreshed every 12 months or whenever a material event occurs, such as a new funding round. Granting options without a current valuation can hit your employees with a 20% federal tax penalty.
Growth and Foreign Qualification – As you use your new capital to recruit talent or open offices in new states, you must register the company as a foreign entity in those jurisdictions. This ensures you are paying local payroll taxes and following local labor laws. Failing to qualify in these states can prevent the company from defending its interests in local courts and create significant tax liabilities as you scale across state lines.
Employment Documentation and IP Assignment – Every new hire should sign a proper offer letter and agreements including nondisclosure obligations and assignment of intellectual property rights by the service providers to the company before their start date. It’s also common for investment documents to require new employees agree to be bound by certain non-competition and non-solicitation provisions. Investors conducting future financing round diligence will expect a clean set of signed agreements for every employee and contractor; gaps in this paper trail can delay or derail your next round.
Managing Contractual Vetoes and Information Rights
Navigating Protective Provisions – Taking outside money creates a contractual relationship where investors hold real power to influence company direction. Your term sheet likely gave them Protective Provisions (veto rights over major actions like taking on debt, changing the business, or selling the company) and Information Rights (access to financials and updates). Legal strategy here is about managing these rights to maintain your operational agility while keeping investors informed and aligned.
Managing Information Rights – Investors are legally entitled to certain financial data and company updates. Strategically managing this flow of information is essential to prevent "informal" investor advice from being interpreted as board direction. Establishing a formal reporting cadence protects the management’s operational autonomy while fulfilling the company’s legal transparency requirements.
Managing the Math of Future Ownership
The legal instruments and terms finalized during the raise establish the framework for the company’s capital structure. Management of this framework requires a precise understanding of how current rights affect your ability to raise capital in the future.
Conversion Tracking and Dilution – You must track exactly how your SAFEs and convertible notes will convert during a priced round. Stacking too many instruments with low valuation caps can lead to massive, unexpected dilution for the entire founding team. If you do not model these conversions carefully, you may realize too late that the founding team’s stake has been significantly more eroded than intended once the instruments turn into equity.
Managing Participation and Pro-Rata Rights – Existing investors often hold the right to maintain their ownership percentage in future funding rounds. These rights must be managed to ensure the cap table remains flexible enough to accommodate the ownership requirements of new lead investors as you scale.
Maintaining transparency and clear communication with your board ensures that investor veto powers do not become a bottleneck preventing the company from reacting to market conditions or closing a future round.
If you have questions about managing your business post-funding, please give us a call at 317.423.7900 or send us an email at info@gutweinlaw.com.
This blog post is part of our 5-part series on Fundraising for Startups. To view other parts of the series, click the links below:
