Alex is Sprintlaw’s co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
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Getting investors on board with your company isn’t just about pitching a great innovation. Investors also want confidence that the company they’re backing is legally sound, well organised and investment-ready.
That’s where legal due diligence comes in. It’s not simply about proving the startup is not doing anything unlawful. It is about showing that the business has strong legal foundations, owns its key assets, has properly documented its arrangements and is prepared for growth.
Why Due Diligence Matters
Imagine you’re an investor with six figures to put into a business. The idea is strong, the market opportunity looks promising and the founders seem capable. But when you look closer, the company has cut corners on its employment contracts, has not properly secured its intellectual property and has not formalised the relationship between the founders in a clear shareholders agreement.
This creates uncertainty. What happens if a key employee leaves? Who owns the company’s core IP? What happens if the founders disagree, or one of them wants to exit the business?
These issues can create significant and unnecessary legal risk. Most investors will be hesitant to put money into a business that has not taken steps to protect itself. Investment is not just about the pitch. Investors want to know that the company is legally sound, owns its assets, has clean records and does not carry hidden risks.
What Is Legal Due Diligence?
Legal due diligence is the process where an investor, buyer, lender or strategic partner reviews a startup’s legal documents, structure and obligations before completing a transaction.
This process helps them understand whether the business has been set up properly, whether key risks have been managed and whether the company has strong legal foundations. No matter how promising a business idea may be, if the business itself is not properly structured or protected, it can become a liability rather than an asset.
In simple terms, legal due diligence is a closer look at the company’s legal health before someone commits money, resources or commercial trust to the business.
When Does It Happen?
Due diligence usually happens once a company has attracted serious interest from an investor, buyer, lender or strategic partner. It is common during fundraising rounds, acquisitions, major strategic partnerships and venture debt arrangements.
Early-stage due diligence is often lighter and more focused on core issues such as company ownership, intellectual property and corporate records. Later-stage funding rounds or acquisitions usually involve a more detailed review, as the amount of money and risk involved is often much higher.
What Actually Happens During The Process?
Due diligence is not something that can be completed in a short 30-minute meeting. It is a structured process that usually involves several stages.
First, the investor or their lawyers will send the startup a due diligence checklist. This is a list of documents and information they want to review before completing the transaction.
The startup will then prepare a data room. This is usually a secure online folder containing key legal, financial and commercial documents. A well-organised data room can make the process much smoother and help the startup appear more professional and prepared.
Once the data room is prepared, the investor’s lawyers will review the documents and may ask follow-up questions or request further information. If legal issues are found, the startup may need to fix them, disclose them or explain how they will be managed.
Once this process is complete, the investor may decide to proceed, renegotiate the deal terms, require certain conditions to be met or, in some cases, walk away.
What Documents Are Usually Reviewed?
The exact scope of legal due diligence will depend on the size of the transaction, the stage of the startup and the nature of the business. However, investors will usually review several key categories of documents to assess the company’s legal health and identify potential risks.
Company Records
Investors may review the company’s incorporation documents, ASIC records, company registers, shareholder agreements and board approvals. These documents help confirm that the business has been properly established, maintained and managed.
Shares and Equity
A startup’s ownership structure is one of the most heavily scrutinised parts of due diligence. Investors may review the company’s cap table, option plans, SAFEs, convertible notes and vesting arrangements to confirm who owns the business, what rights different parties have and whether any future ownership issues may arise.
Intellectual Property
For many startups, intellectual property is one of the company’s most valuable assets. Investors may review IP assignment agreements, contractor agreements, trademarks, software ownership arrangements and any relevant licensing arrangements to ensure the company properly owns and controls its intellectual property.
Employees and Contractors
Employment and contractor arrangements can create significant legal risk if they are not properly documented. Investors may review employment agreements, contractor contracts, confidentiality obligations, workplace policies and employee share scheme documents to assess whether the business has protected itself appropriately and complied with its obligations.
Commercial Contracts
Key commercial agreements are also commonly reviewed. This may include customer contracts, supplier agreements, partnership agreements and terms of service. Investors will often look closely at contracts that are critical to the company’s revenue, operations or growth.
Compliance
Depending on the industry, investors may also examine the company’s compliance obligations. This can include privacy and data protection practices, licensing requirements, consumer law obligations and industry-specific regulatory compliance.
Disputes
Investors will usually want visibility over any current or threatened disputes involving the business. This may include founder disputes, unpaid debts, customer complaints, employment issues or ongoing legal claims.
Common Red Flags
During legal due diligence, investors are usually looking for issues that create uncertainty, increase legal risk or may affect the value of the business.
Common red flags include missing intellectual property assignment agreements, unclear or inaccurate cap tables, undocumented equity promises, unsigned contracts, employee and contractor classification issues, privacy or compliance gaps, and founder disputes or ownership disagreements.
Not every issue will stop a deal from proceeding. However, unresolved legal problems can delay investment, reduce investor confidence or lead to renegotiated terms.
What Happens If Problems Are Found?
Finding issues during due diligence does not necessarily mean the deal will fall apart. In many cases, legal issues can be fixed before the transaction is completed.
For example, the company may need to update agreements, formalise missing documents, correct corporate records or strengthen its compliance processes. In other cases, investors may require additional protections, revised deal terms or specific conditions to be satisfied before proceeding.
More serious issues, particularly those involving ownership disputes, intellectual property or regulatory compliance, may have a larger impact on the transaction.
How Startups Can Prepare
Preparing for legal due diligence early can make the fundraising or transaction process much smoother.
Startups can reduce risk and improve investor confidence by keeping company records organised, using properly drafted written agreements, ensuring all intellectual property is assigned to the company, maintaining a clear and accurate cap table, preparing a data room early, reviewing privacy and compliance obligations regularly and addressing known legal issues before fundraising begins.
Good legal preparation not only helps startups avoid delays during due diligence, but also demonstrates professionalism and strong business management.
Final Thoughts
Legal due diligence is not just a box-ticking exercise. It is a process that helps investors understand whether a startup is legally prepared for growth, investment and increased scrutiny.
For founders, preparing early can make the investment process smoother, reduce delays and give investors greater confidence in the business.
If you would like a consultation on preparing for your startup's legal due diligence process, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
Alex SoloCo-Founder
