When founders start working on their products, they usually pay little attention to formalities. However, this casual approach can lead to issues when it comes to securing investments.
In this article, I’ll explain what founders should settle at the pre-seed stage to maximize the company’s chances of attracting top-notch investors—and to avoid internal conflicts.
Define managerial roles
Startups typically begin as a group of like-minded individuals who get excited about a business idea and dive in together. Early on, everyone’s juggling many roles, and that’s fine. However, it’s crucial to clarify who will handle which responsibilities in the future. For example, designate who will be responsible for technology, sales, or finance.
I’d suggest making these roles official—maybe by putting together a partnership agreement. Scribbling something down on a napkin is better than having nothing at all. In U.S. or U.K. jurisdictions, there have been cases where a napkin agreement helped win million-dollar lawsuits.
Why is this important? It clarifies each party’s interests, creates a shared vision for the future, and transitions these understandings into a formal structure. Once money is on the table, disagreements over decisions can spark conflicts. And conflicts have toppled more than one company.
Secure Intellectual Property Rights
When you have an MVP and plan to bring on an investor, ensure you formally secure intellectual property rights.
In IT, the product is usually the code. The founders can write it, but often, it’s made by hired developers who are paid for it. In both cases, it’s legally unclear who owns the code. Now, imagine yourself pitching this product to the investor. It’s like convincing someone to buy an uncommissioned house.
If you outsource coding, I advise signing a development agreement formally transferring intellectual property rights to a specific founder or group of founders. Likewise, if you write the code yourself, ensure you establish the IP rights accordingly.
At the pre-seed stage, I recommend setting up IP rights with individuals. This approach can simplify structuring the company at this early stage. Investors may have different visions regarding business structure or even the company’s future jurisdiction. It’s often more practical to form a legal entity when securing financing, assigning IP rights directly to the founders.
This more flexible method can help avoid unwanted tax burdens or excessive administrative efforts. It also minimizes the risk that an investor might back out due to structural inconsistencies.
Take care of NIS-2 compliance
Everyone doing business in the EU already knows what GDPR is and why ensuring proper compliance is important. However, startups have also had to consider something else recently.
On October 18, 2024, the EU adopted a new NIS‑2 resolution (Network and Information Security, the second version of the original NIS introduced in 2016) – a regulatory act that requires digital product developer companies to invest in their cybersecurity.
The big change from before is that NIS-2 isn’t just a suggestion anymore; it’s a must-do. Whereas issues of data protection and cybersecurity financing in EU Member States were previously left to the discretion of individual companies, they are now binding requirements. Plus, there will be hefty fines, kind of like the ones for GDPR breaches, for those who don’t comply.
This big change will mean a lot for companies whose products fit the NIS-2 criteria. In particular, their cost structures will change, as they will now be required to ensure dedicated funding for cybersecurity.
So, I’d tell startups with products that meet NIS-2 to think about compliance early and set aside some budget for it right from the start. Doing so will help avoid misunderstandings with investors regarding the financial burden at all phases of product development.
Document (in)formal agreements
Suppose you’re about to meet with investors, not just for a beer or coffee but having a substantive conversation about a possible deal. In that case, I suggest you document the preliminary agreements in meeting minutes and then share them with the investor.
This ensures that both parties are on the same page. Later, these notes can serve as a reference when resolving any issues.
Sign a Term Sheet
Once you’ve formalized internal relationships, secured IP rights – and found a potential, industry-savvy investor, you will get to the term sheet. This document outlines the conditions under which the investment agreement will be signed—it’s like a technical specification for the contract.
While a term sheet carries less legal weight than the final contract, it provides both parties with peace of mind by laying out the key provisions of the future deal, like:
- Company Valuation: The agreed value of the company within the agreement
- Investment Amount: The sum to be invested
- Equity Stake: The portion of the company the investor will receive
- Investor Privileges: Any special rights or privileges granted to the investor
- Use of Funds: A plan for how the investment will be used
- Exit Terms: The timeline and procedures for the investor to exit.
- Confidentiality: NDA provisions.
- Intellectual Property Status: The state of the project’s IP rights.
Often, after signing the term sheet, further preparatory steps are needed. For example, the investor might need to transfer funds to an escrow account while the startup registers a legal entity and transfers the IP rights accordingly.
Set conditions of the investment agreement
Any agreement’s purpose is to clearly define the relationship between the company and the investor, who is providing funds under specific conditions.
There are various common formats for investment agreements between investors and startup founders—a topic extensive enough to merit its own discussion. For example, it might be a Convertible Loan—where the investor provides funds for a set period at a predetermined interest rate—or a SAFE (Simple Agreement for Future Equity), where the investor gives funds in exchange for future equity or repayment under specified conditions.
Beyond the terms of investment, it’s crucial to define the conditions for parting ways. For example, what happens if a founder no longer sees a future with the company or if the investor decides to cut ties for any reason? Conflicts may arise without predetermined legal and financial exit terms, potentially jeopardizing the business. Establishing a buyout procedure, setting a fixed-price evaluation, defining timelines, and more is essential.
Founders must also ensure that as the company grows and secures additional funding, their shares aren’t diluted to the point where they lose control over their own business. A lack of such guarantees can even be a red flag for future investors. After all, if the founders can’t manage their own business, they lose motivation—and that’s bad news for everyone.
