When a startup is on the verge of a major financing round or an acquisition, the spotlight shifts fast. Investors and buyers are doing their homework, and they are not just evaluating your product, your team, or your market. They are looking under the hood at your legal and corporate structure. If what they find is a mess, it does not just slow things down. It can kill the deal (in the most dramatic situations), trigger unexpected tax bills, or hand the other side leverage they should not have.
At SPZ Legal, we work with startups at every stage, and one of the most common engagements we take on is a corporate audit. This is a systematic review of a company's legal foundation before a financing or exit. Think of it like a 65-point tune-up checklist for your car, except instead of checking your brake pads and tire pressure, we are reviewing your cap table, your equity documentation, your IP assignments, and more. And we have recently built out some fantastic AI workflows to help make this corporate audit streamlined.
What we find is remarkably consistent. The same six issues come up again and again. Here is what they are, why they matter, and why you are better off fixing them before a term sheet lands in your inbox.
If you are just getting started, you may also want to read our post on Top 5 Legal Mistakes Startup Founders Must Avoid. Some of the issues overlap, but this article focuses specifically on what needs to be cleaned up when a deal is on the horizon.
Short Answer: Filing a certificate of incorporation is just the first step. Many founders stop there (or otherwise do not complete all of the steps to complete an incorporation) and leave critical corporate formalities undone.
Online incorporation services like Clerky and Stripe Atlas have made it easier than ever to get a Delaware corporation off the ground. But these platforms walk you through a multi-step process, and a surprising number of founders treat the initial filing as the finish line or otherwise do not complete all of the steps to properly close out an incorporation.
Filing your certificate of incorporation establishes your company as a legal entity in Delaware. That is it. What comes next is equally important: forming a board of directors, adopting bylaws, appointing officers, and formally issuing stock to the founders. These are not optional formalities. They are the legal scaffolding that holds your company together.
When we onboard a new client preparing for a financing, we often ask them to send us everything they have. What we sometimes receive is a folder full of unsigned draft documents. If those documents were never executed, the company may not be properly organized, and that creates real exposure from both a corporate law standpoint and a tax standpoint.
The fix is usually straightforward, but it is far easier to do before investors are watching.
Short Answer: Waiting too long to issue founder stock can result in a significant, avoidable tax bill, especially once a term sheet is on the table.
This is one of the most consequential mistakes we see, and it is one that founders often do not realize is a problem until it is almost too late.
When a corporation is brand new (no revenue, no commitments, no investors), you can typically justify issuing founder stock at par value, which is often $0.00001 per share. For a founder receiving 4.5 million shares, that is a total cost of $45. That is not a typo. The IRS accepts this because the company has no meaningful value yet.
Here is where it gets tricky: the moment a term sheet arrives from an investor, the company's valuation spikes in the eyes of tax practitioners. You do not have to have received the money. You do not even have to have signed the full investment documents. The term sheet itself is enough to establish a new, higher fair market value for the stock.
So if a founder comes to us with a signed term sheet for a $6 million investment and has not yet issued their founder stock, they may now be looking at issuing stock at a significantly higher value, plus a tax bill to match.
The lesson: issue founder stock early, follow the proper corporate formalities (board approval, documentation, payment), and do not wait until you have investor interest to get this done. Our post on 10 Essential Steps to Prepare for Seed Investment walks through the broader preparation process.
Short Answer: An offer letter that mentions equity is not the same as actually issuing equity, and you cannot backdate the valuation.
This one catches a lot of founders off guard. A startup hires an early employee and includes a line in the offer letter: "You will receive 25,000 shares." The founder assumes that is enough. It is not.
Issuing stock or options requires formal corporate action. There needs to be board approval, proper documentation of the grant, and the equity typically must be issued at fair market value on the date the board approves it. You cannot retroactively apply the value from when the offer letter was signed.
We frequently see companies with a backlog of equity grants that were promised but never formally issued. Sometimes the founders know this and assume they can clean it up later.
Sometimes they genuinely believe the offer letter was sufficient. Either way, the result is the same: a diligence problem that needs to be resolved before investors will get comfortable.
The longer you wait, the more complicated it gets, especially if the company's value has increased in the interim. For a deeper look at how equity compensation works, see our Guide to Equity Compensation for Startups. You may also find our post on Issuing Equity to Service Providers helpful.
Short Answer: Missing the 30-day window to file an 83(b) election can result in significant, ongoing tax liability every time your stock vests.
If you receive stock that is subject to vesting (and virtually all founder and employee/advisor stock should be), you need to file an 83(b) election with the IRS within 30 days of receiving that stock. No exceptions. No extensions.
Here is why it matters: without an 83(b) election, you are taxed on the value of the stock each time it vests (and for employees, the company has a corresponding withholding obligation). If your company's value is growing (which is the goal), that means a potentially large tax bill every year, based on the then-current fair market value of the shares that vest. For a founder holding millions of shares in a company that is scaling, this can be financially significant.
An 83(b) election flips the script. It says: tax me now, on the full grant, at today's value. If you are issuing stock at par value early in the company's life and you pay that value for the stock, the tax is essentially zero. And once you have made the election, you will not owe taxes again until you actually sell the stock.
Investors will ask for your 83(b) elections during diligence. If they are missing, it raises red flags about both the individual's tax situation and the company's overall governance. There are some cleanup options if you missed the window, but none of them are without their own side effects.
File the election. File it on time. It is one of the highest-leverage, lowest-cost things a founder can do.
Short Answer: If everyone who contributed to your company has not signed an IP assignment agreement, you may not actually own your own intellectual property.
This one is especially critical for technology companies, where the product itself is the business.
Every person who provides services to your company (founders, employees, contractors, advisors) should sign some form of IP assignment agreement. The specific form may vary: an advisor might sign an advisor agreement with an IP assignment clause, while a core developer might sign a more robust standalone agreement. But the principle is the same: the company needs to own what it paid people to build.
The risk of not doing this becomes very real when someone leaves. If a former contractor contributed meaningfully to your codebase and never signed an IP assignment agreement, they may have a colorable claim to ownership of that work. When you go to them later (after they have moved on and have no particular reason to cooperate) and ask them to sign a cleanup document, the answer is often: "What is in it for me?"
That is a negotiation you do not want to be having in the middle of a financing or acquisition.
Get the agreements signed at the start of every engagement, before any work begins.
Short Answer: Putting your own money into your startup without documenting how it is treated creates legal, tax, and governance problems that investors will flag.
Early-stage founders often fund their companies out of pocket. They cover expenses, pay contractors, and keep the lights on before outside capital arrives. This is completely normal. What is not okay is doing it without any documentation of how those funds are being treated.
Is it a loan? Is it an equity investment? Is it a gift? If you cannot answer that question with a signed document, you could have a problem.
Commingling personal and business funds is a red flag for investors and a violation of basic corporate governance principles. Beyond that, there are real legal and tax consequences depending on how the contribution is characterized. Simply issuing yourself additional stock in exchange for the cash infusion is often not the right answer either, because doing so prices the company and can spike the value for everyone else on the cap table.
The right approach depends on the circumstances. A SAFE (Simple Agreement for Future Equity) is one common option. A promissory note treating the contribution as a loan is another.
For very small amounts, the analysis may be simpler. But in every case, the decision should be made thoughtfully and documented properly.
There is a temptation among founders to defer legal cleanup until there is money on the table. The logic makes sense on the surface: why spend money on legal work before you know you have a deal?
Here is the problem: once a term sheet arrives, the clock is ticking, the pressure is on, and some of these issues become significantly harder and more expensive to fix. Tax consequences that could have been avoided entirely may now be unavoidable. Investors who are already nervous about business risk do not want to see legal risk on top of it.
Proactively cleaning up these six areas before you are in a financing or exit process does more than just protect you legally. It signals to investors that you are a founder who crosses your t's and dots your i's. That you are someone who has proper controls in place and can be trusted with their capital.
That is not a small thing. In a world where investors are taking a significant leap of faith on your business, giving them confidence in your legal foundation is one of the best investments you can make.
For more on how to prepare your company for a deal, see our posts on Due Diligence Best Practices: Be Prepared for M&A Success, Questions Venture Capitalists Ask During Due Diligence, and Startup Exit Strategy: Preparing for M&A Success.
When should a startup conduct a corporate audit?
Ideally, before you begin actively seeking investment or entertaining acquisition conversations. The earlier you identify and fix issues, the more options you have, and the lower the cost of remediation.
What happens if we have already received a term sheet and have not done this cleanup?
It is not too late, but some issues become harder to resolve. Certain tax consequences may be unavoidable. You should engage experienced startup counsel immediately to assess what can be fixed and how.
Do we need to file an 83(b) election for stock options?
In most cases, no. 83(b) elections apply to stock grants subject to vesting, not to stock options. Options have their own tax treatment rules, but the 83(b) election is specifically for stock. However, if early exercisable stock options are used and the optionee early exercises, an 83(b) election is typically needed at that phase.
What if a former contractor refuses to sign an IP assignment agreement?
This is a real risk, and it can create significant complications in a financing or exit. In some cases, it may require negotiation, legal action, or even redoing their work from scratch without reference to their work. The best solution is prevention: get agreements signed before work begins.
How should a founder document money they have personally put into the company?
It depends on the amount and the circumstances, but common approaches include a SAFE, a promissory note (loan), or in some cases treating it as additional paid in capital. But in any case, the decision should be intentional and done thoughtfully.
The six issues outlined above are not obscure edge cases (nor are they an exhaustive list!). They are the things we fix in diligence over and over again. The good news is that all of them are preventable, and most are fixable, as long as you act before a deal is on the table.
A clean legal foundation is not just about avoiding problems. It is about showing up to a financing or exit as a company that investors can trust. That trust is earned through the details, and the details are exactly what we are here to help you get right.
Need guidance on corporate diligence and financing readiness? Get in touch with our team to start the conversation.