If there is one consistent theme that I have seen across all startup and emerging growth companies, it’s the complete disarray found in retaining, managing and storing key company documents. This isn’t a virus that affects only certain companies, or only young companies for that matter. I’ve seen this piranha of a problem at every stage of a company’s life cycle, and at small companies and big companies alike. Early on, entrepreneurs focus on matters geared towards de-risking the business (e.g., concept and product development, product/solution fit, product/market fit, customer acquisition and, hopefully, the identification of a repeatable and scalable business and revenue model). History shows that early success (and growth) comes from finding that repeatable and scalable model, not so much from having a well-organized document database. What are great documents if there’s no company, right? In the end, entrepreneurs lean towards what they know, so product and design or “solving the problem” rank towards the top, meticulous document management towards the bottom.
But in the long run, even small attempts at retention, management and storage of key company documents can have huge payoffs – both in time, money and personnel resources. Depending on the extent of the problems, I’ve seen due diligence and key company document cleanup add upwards of $25,000 to the cost of a Series A round. In addition, poor or non-existent documentation may put significant leverage into another party’s hands to force the company to re-negotiate an agreement under the pressure of the Series A round because the company did not earlier document a particular arrangement that is now a sensitive issue in the Series A round due diligence (i.e., vendor terms, founder equity splits – the list goes on and on). You don’t really know when you may be hit with your first due diligence request – whether it’s from an angel investor, an institutional venture capital fund or possibly a large strategic acquirer. Or maybe it’s not due diligence. Maybe you are in a dispute with one of the few customers you’ve landed and no one in the company can locate the final, signed version of the customer contract that contains the terms the customer now claims were never agreed to. In any event, nothing can break confidence faster than an inability to quickly and efficiently produce good, quality signed company documents that have all pages, dates, exhibits, etc. At a certain point during due diligence, you can only explain away so many unsigned agreements, conflicting versions, missing pages or altogether missing documents. Expect deals to slow to a crawl and legal expenses to sky rocket while key company documents are hunted down and cleaned up.
You should know that as time passes, the problem worsens. The best analogy I can give is magnetic declination – the variance between true North and magnetic North when navigating with a compass.
If you don’t compensate for magnetic north, and you only walk 20 feet the variance in degrees between true North and magnetic North is miniscule. You will not be too far off course. Further, if you don’t compensate for magnetic north, and you walk “10 miles” then you will be more off course than you could have ever imagined because the farther you walk the greater the variance between true North and magnetic North. Don’t find yourself at the doorstep of a deal of a lifetime but 10 miles off course when it comes to the retention, management and storage of your key company documents.
So what’s my cost-effective and efficient solution for startup and emerging growth companies? There’s one piece of advice that I give all startups (and, frankly, any entity that I start working with). On the date of formation (or the date we start working together), you should take a version of a good due diligence checklist (not the kind you’d receive in a venture capital or private equity financing, but a good buy-side M&A due diligence checklist) and set up a “legal drive” on a company server with folders and sub-folders organized and numbered consistent with the due diligence checklist. See here for a good example of a checklist: Form Due Diligence Checklist
Create a process where a final, clean Word version and a final, clean and fully executed PDF version of any key company document (or any document that would be responsive to the due diligence checklist) are saved to the appropriate folder or sub-folder on the legal drive immediately after execution. I would also limit who in the company has access to this legal drive to maintain a good chain of custody. Limiting who has access will also filter out people that are more apt to be saving documents that don’t have a clean bill of health (i.e., un-signed, missing pages, etc.). From day one, continue to fill in all of the due diligence checklist items as you accumulate them. Much like the adage, you can’t boil the ocean all at once, large databases of good, clean documents are better compiled along the way in dribs and drabs than in a last minute emergency prep for a deal. And make sure to include the Word version (you’d be surprised how often you go back to amend or revise an agreement and no one can find the final, clean Word version and the entire document needs to be re-fashioned). Be sure if you amend or modify any agreements, that those amendments end up in the legal drive paired with the primary agreement.
Good luck out there!