Before Raising Money – Identify Your Liabilities

As more social enterprises seek to obtain investment capital to help grow their business, it is important for Officers, Directors, and Founders to identify potential liabilities, and deal with them, before seeking financing.

Many early stage companies have known outstanding liabilities facing them that must be addressed prior to raising investor capital.  Whether it’s a founder who moved on before things took off, a former employee or independent contractor who left the company, or other entity who may have a claim of equity in the company or money owed, nothing can derail a potential financing faster than some third party catching wind of the potential for investment money, and making a claim for equity or seeking payment of funds owed.   Investors do not want to put money into companies that will be forced to use that capital to settle old debts, they want their funds used to grow the enterprise.

Further, if your company is successful at raising money, any liability that arises which was not disclosed in the due diligence process can trigger massive problems for management, anger the investor who may feel misled or duped, and halt any forward momentum that your company has.  In a worst-case scenario, an investor would seek to recover their funds on the basis that they were not provided good faith disclosure from the company during diligence.

Accordingly, for any company considering the prospect of seeking investment capital, it is important to sit down and identify any and all potential liabilities that are currently facing the company, as well as any potential liabilities that may come up.  For any former employees or other individuals who have left the company, make sure you have releases (generally in the form of a contract or settlement agreement) acknowledging that they are owed nothing further by way of payment, and have no claims of ownership in the company.

If you don’t have a release, try and get one.  For any former employees or contractors, provide them with a final accounting of their time with the company and inquire if anything is missing.  If you are smart about your communication with these individuals, you will be able to reach out to them without disclosing that you may be seeking investor capital.

Ultimately, a company cannot ever fully insulate itself from the prospect of liability.  What a company can do, however, is deal with potential liabilities in an intelligent manner.  That way, when a company seeking investment capital faces a due diligence checklist, it will be able to provide executed documents evidencing that previous founders, employees, or contractors have all released any claims they may have.  Such assurances can go a long ways with investors, who will be more confident that their money will be used to grow the business, and more confident in a management team that has the organization and wherewithal to minimize its exposure.