
YC's Series A Diligence Checklist - akharris
https://blog.ycombinator.com/ycs-series-a-diligence-checklist/
======
sebleon
> The more sophisticated hires will realize this and you may then have to
> increase their compensation (in equity, cash or both) to make up the
> difference to avoid a morale issue.

What about the less sophisticated hires? Employees are trusting founders not
to screw them over. I'd expect this piece to advise either: a) educating less-
sophisticated employees, or b) increasing compensation for all employees that
didn't get their equity grants before the term sheet.

~~~
throwaway2016a
The part right above it is interesting too...

> If you have any pending or promised equity grants you haven’t already taken
> care of before you start your Series A process, do that ASAP.

Huh? Seriously? If someone promises me equity I expect that finalized within
weeks. How many companies just have promised equity sitting around without the
paperwork being done?

Edit:

Some super good points about board approval. Most of the company's I've worked
at have the rules of the options pool voted on by the board but the grants can
be given out without board approval (as long as they were the standard new
hire grant and nothing unusual). But I can see how if something like that
isn't in place it could take a while.

~~~
icedchai
Tons. This happens all the time. Equity grants take months. I was promised x%,
at hire. By the time I got my equity grant, I was already diluted.

~~~
throwaway2016a
I'd like to add the word "can" in there. "Equity grants [can] take months."
They shouldn't though. They can take as little time as it takes the president
or CEO to hit the "print" button and get out a pen if the rules are laid out
clearly and voted on ahead of time by the board.

~~~
jforman
All three startups I have been involved with have had board-level approval for
individual equity grants. I have never seen any real push-back on them, but I
have also never heard of the board relinquishing control over something so
vital.

The employment contract guarantees the equity subject to board approval. I'm
not quite sure why people are making such a big deal out of this.

~~~
throwaway2016a
What you describe is certainly common. I have a different experience and I
like what I have seen better.

> The board agrees all new employees get X options with a 1 year cliff and 4
> year vesting without additional approval so long as total options granted
> does not exceed Y.

The board only needs needs to be involved if X or Y need to be changed.

Having the board bother themselves with every little hire is just ridiculous.
They have better things to do. Plus if the options are defined on paper the
company can't be accused of favoring certain classes of employees differently.

------
tptacek
* _Any agreements, understanding, instruments, contracts or proposed transactions to which the Company is a party or by which it is bound which involve obligations of, or payments to, the Company in excess of $25,000._

* _Any licenses or agreements of any kind with respect to the Company’s or others’ patent, copyright, trade secret or other proprietary rights, proprietary information or technology, including employee confidentiality and proprietary information agreements._

* _Any standard forms of agreements used by the Company._

* _Any confidentiality and nondisclosure agreements._

* _Any consulting contracts._

Consultants: this is one reason why it's often easier to get in the habit of
working off your client's paper than trying to get them to accept your own. A
lot of startups might not care, and will accept your MSA. But for some of
them, accepting a new MSA creates a huge amount of hassle down the road.

------
toomuchtodo
> If the Company has any foreign employees, separately list (by country) all
> benefits provided to foreign employees.

How does this work for startups employing their foreign employers as
independent contractors? Also, it might be helpful to mandate startups provide
documentation how they're adhering to local labor regulations in countries
outside of US jurisdiction (especially if you're a US company hiring in
Europe; their local labor regulations differ substantially from US labor law).

Also, under Material Agreements, I don't see anything called out for
compliance with GDPR for startups expecting to or currently serving users in
the EU. Does YC perform diligence in this regard considering the 4% of annual
revenue penalty for those in violation of the GDPR?

Very helpful resource, really appreciate YC sharing it.

~~~
jasonkwon
For foreign contractors the biggest questions are almost always going to be
(1) are they developing any IP/tech, (2) if so, have they all signed contracts
that ensure the company owns the IP they are producing and (3) how
enforceable/valid are those contracts in the country they’re in. You can knock
off a lot of that inquiry by making sure you have answered these questions
yourself before hiring foreign contractors (or employees for that matter) and
using a country specific contractor agreement where appropriate. Then it’s
mostly a matter of sharing those materials and confirming that everyone signed
them when you’re in the diligence phase.

You’re right that labor laws are different depending on the country. For
example - things like mandatory severance or mandatory “notice” periods before
letting someone go. Equity grants can also be impacted (some countries
effectively make it impossible or very difficult to enforce vesting). These
things are usually surfaced in the process of disclosing against the
representations you’re required to make in the fundraising docs. They’re less
about diligence materials you share.

Re: GDPR - excellent point. It’s something people look at depending on what
the company is doing. The checklist asks for the company’s TOS and privacy
policy which is one of the starting points. Usually what happens if it’s an
issue is that there will be a call or email exchanges with questions. It’s a
more case by case inquiry.

~~~
toomuchtodo
Thanks for taking the time to reply. I hope my questions did not come off as
condescending; if so, it was not intended.

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mbesto
I try to tell companies this all of the time - keep your books/contracts in
order and diligence is a breeze. If you're expecting a Series A, and you
aren't a household name, the diligence process will slow your business down,
so plan ahead at a pace that doesn't disrupt your business.

------
fab1an
Great move to make this transparent to founders, even at an early stage. I'd
argue it even makes sense for founders to file their entire paperwork in a
folder structure that reflects this set up _from the get go_.

What looks like an unnecessary distraction in the early days will save you
time and headache later down the line.

You have to file your documents either way, so why not make sure they are
already in a format that's ready for due diligence - once an investor or
acquirer comes knocking, you basically have most of your data room ready.

~~~
speedplane
Even if a founder does not have all these documents put together, having a
simple checklist like this to know what they're missing is pretty valuable.

------
heynk
Is there any kind of diligence for seed investments? I know there is the
obvious YC application process, with an interview or two. After that, are
there background checks? References? Anything like that? I know there isn't
much to do diligence on with companies that are often just an idea.

~~~
apsec112
Just one experience, but the CEO of a startup I used to work for faked his
college degree and had previously been sued by the FTC. (We found out only
after he blew up the company.) None of the investors we talked to noticed
anything.

~~~
tptacek
The kind of diligence we're talking about here wouldn't catch that. We're
talking about the nuts-and-bolts business documentation required for an
investor to take a stake in your company, not founder background checks.

~~~
jacquesm
A proper due diligence will definitely include founder background checks, as
well as background checks for other key personnel or executives. For a seed
round or small investment (<$2M or so) such things are usually not done.

~~~
tptacek
Clients routinely background checked us at Matasano; I know because every time
it happened, I had to sign a release to allow it to happen (as did any other
team member who was checked).

When a public company _acquired_ us, in a process very similar to this one
that also involved a 6-figure legal review bill, I did not sign a background
check release, or even a credit check.

I would be surprised to learn that A round investors routinely do _stricter_
checking than a _public company_ doing a _full acquisition_.

~~~
jacquesm
> When a public company acquired us, in a process very similar to this one
> that also involved a 6-figure legal review bill, I did not sign a background
> check release, or even a credit check.

> I would be surprised to learn that A round investors routinely do stricter
> checking than a public company doing a full acquisition.

That's easily explained: when doing an acquisition the _company_ is the focus,
not the executives. When doing an investment the team that you are effectively
partnering with is a very important part of the deal.

Post acquisition a player with a troublesome past that was not disclosed could
be easily discarded especially since this would be considered a lack of
disclosure, but in an investment scenario where that player (and/or their
buddies) holds the majority of the stock that is not so easy.

~~~
tptacek
Is this something new? I haven't managed or been a direct party to a funding
round, but I've been a founder during one A round and key staff at another and
never signed background checks for those. What kind of investor was this that
required background checks?

A public company that acquires a company managed by a felon might have to
_restate financials_ or _write down part of an acquisition 's value_, which
leaves me wondering about the supposed disparity.

~~~
jacquesm
I've been in this for a decade, so no, it's not new, but it could very well be
a European thing. Even so, I find it hard to believe US investors would cut 7
figure or higher checks without wanting to know who they're getting in bed
with.

> What kind of investor was this that required background checks?

A fairly large portion of them, with an accent on financial services and
health care related affairs as well as two sided marketplaces because of the
potential for fraud and money laundering.

> A public company that acquires a company managed by a felon might have to
> restate financials or write down part of an acquisition's value, which
> leaves me wondering about the supposed disparity.

Well, whether or not they are a felon isn't as important as whether or not
they are currently up to something that is not proper. And that's the first
thing a DD tries to find out and a background check could help to flag
potentially problematic cases.

If I came across a financial services company run by someone who has already
had a fraud charge stick that would definitely result in a mention to the
investors and could very well result in a deal not going through.

------
jacquesm
Great list!

I'm missing a chattel (I hope that's the right term in English) or asset list
and in the IP section a list of licenses obtained as well as statements of
non-retention by former employees and executives.

Furthermore a statement of compliance with the various applicable laws
(retention, privacy and so on) would be very useful, as well as the disclosure
of the results of any audits the company has undergone.

~~~
adventured
I have to second the local privacy aspect, and compliance with any applicable
local laws around information handling. The word privacy doesn't show up once
on that checklist. It should probably be a separate item under Material
Agreements. As an issue, this is only going to get a lot more important.
Particularly for US start-ups pushing into European markets. Investors are
going to start universally requiring to see it broken out for each market
that's important to the company.

------
foobaw
This list may seem daunting to a lot of people, but as a "noob" startup
founder, most of these become self-explanatory as you go along.

Just make sure you keep a record of everything you do officially and get help
in legal/accounting in any questionable aspects of your work.

Don't wing anything. Don't be lazy, be super detail-oriented in everything and
you'll be okay.

~~~
tptacek
I've never participated in the DD for a series A but have been a party to the
DD for an acquisition, and it looks daunting because it is daunting. During an
acquisition, not only are you collecting this information (which, if you
didn't spend a constant, tedious amount of energy over the life of your
company to keep up with, is itself a monumental pain in the ass, for each each
step might incur several weeks of lag), but _legal then bills you to review
each of them_. It can cost hundreds of thousands of dollars.

~~~
jacquesm
> It can cost hundreds of thousands of dollars.

If you're lucky and the deal goes through you get to pay that out of the
investment, if you're _unlucky_ and the deal does not go through due to major
surprises during the DD then you may end up not being able to raise at all and
you'll still bear the costs, if the surprises are due to the company failing
to properly disclose stuff early on that they could have reasonably been
expected to know about then there is a fair chance they will end up being
saddled with the costs of the counterparty.

------
StephenSmith
Also, all software libraries used and the licenses those libraries use.

------
walru
This is slightly off topic, but is there anywhere to see a full swath of YC's
incubators and their level of (current) success?

~~~
auvi
you mean this? [http://yclist.com/](http://yclist.com/)

~~~
walru
Amazing! Thank you.

------
baybal2
This is a really long list. How much of this is needed due to US securities
law and how much to say "hey, you are really doing this on your own volition,
all of our cards are on the desk?"

So much for a private sale of shares. In Pakistan, a proper listing agent can
put your company on the stock exchange in under 2 month with most of this time
just waiting for permits to arrive through snail mail.

~~~
patio11
There is a saying in certain engineering fields that all regulations are
written in blood; an accident was once caused due to the lack of a particular
line item and now that line item is on the list.

This is a relatively short list for due diligence. While far less dramatic
than an engineering fault which could actually kill someone, there have
_absolutely_ been extremely expensive incidents in the US which occasioned
each item on this list. A portion of them are due to peculiarities of doing
business in the United States, which is organized to accomplish many forms of
dispute resolution via a professionalized process backstopped by formal legal
process, in a fashion which may not be similar to e.g. Pakistan, Japan, most
European countries, etc. US companies do frequently generate more legal work
than comparable situated companies in other jurisdictions. (There are
varieties of work they generate less of, but I'll leave that out of the scope
of this comment.)

The legal profession, like all service professions, sometimes recommends work
which is not directly in the customer's interests, but in the main it is in
the business of decreasing transactional risk. There are _material_ risks
involved in investing in a company with undisclosed baggage. Additionally,
insisting on a certain level of professionalism helps to shake out _other_
problems, because firms which cannot self-organize to e.g. provide a list of
all employees and the paperwork related to them are _almost certainly_
catastrophically managed under the hood. You might not even be creative enough
to successfully predict how they're going to blow up, because the theoretical
space of mistakes one can make is infinite, but you know that anyone who can't
produce a signed copy of an employment agreement on demand is _highly
unlikely_ to have a level of risk which is roughly representative of your
experience from the distribution of companies which are at least minimally
competent.

~~~
cool-RR
Hi Patrick.

You write interesting things, but I think that your language is too passive /
indirect and full of big words. It'll be easier to understand if it was more
simple and direct. Just my two cents.

~~~
euroclydon
I’ve thought similar, but 1) Patrick is a smart guy and undoubtedly self
reflective enough to understand his writing style, and 2) HN upvotes affirm
what he’s doing.

Now, my theory is the Japanese culture values this style of communication as
much as it doesn’t value directness. The reason is there are many avenues to
save face when not directly confronted.

You can see this in the way people spoke to each other when disrespect would
lead to a dual. And this is still the predominant speech style in US
legislature.

