Learn how capital structure, investor rights, governance, and equity issues can create challenges during diligence and affect financing or acquisition opportunities.

Many founders assume that if revenue is growing, investors are interested, and the business has momentum, a financing or acquisition opportunity will naturally move forward.

In practice, that is not always the case.

At Wood Stabell Law Group, we have seen situations where a company appears well-positioned for a transaction, only for the process to slow down or stall during diligence. In some cases, the issue is not the strength of the business itself. Instead, it is the capital structure and legal framework underlying the company.

While every company is different, there are several structural issues that commonly create challenges as businesses grow.

1. Raising Only Enough Capital to Address Immediate Needs

Early-stage companies often face difficult decisions about financing. In some situations, founders raise enough capital to address an immediate need rather than raising sufficient capital to support the next stage of growth.

As a result, the company may rely on a series of bridge financings or short-term funding arrangements over time.

Each financing may solve an immediate problem, but multiple layers of financing can create complexity within the company's capital structure. As additional investors become involved, they must evaluate and understand the rights and obligations associated with prior financings. This additional complexity can slow transactions and increase diligence requirements.

2. Investor Rights and Expectations That No Longer Match the Business

Investment terms that make sense when a company is young may not align with the company's future growth path.

Provisions such as:

• Anti-dilution protections
• Liquidation preferences
• Consent rights
• Other investor protections

are often negotiated based on expectations about the company's future investor base and financing strategy.

Over time, circumstances may change. The investors originally anticipated may never materialize, while the contractual provisions remain in place.

When that happens, relatively routine corporate actions—including additional financing transactions—may require approvals from early investors. For founders who are moving quickly, the governing documents may create friction that becomes apparent during investor or buyer diligence.

3. Governance Structures That Complicate Decision-Making

Founders frequently focus on ownership percentages. Investors and buyers, however, also evaluate who controls the company and how decisions are made.

As companies scale, governance structures that worked during the early stages of growth may become more restrictive or difficult to navigate.

In situations where decision-making authority, ownership interests, and other business relationships are structured in ways that create complexity, investors may view governance as a risk factor during diligence.

As a result, governance structure can become just as important as ownership percentages when evaluating a company's readiness for growth, financing, or an eventual transaction.

4. Early Equity Decisions That Create Long-Term Challenges

One of the most significant issues that can emerge during diligence involves early equity grants.

In the early stages of a company, founders often grant equity to individuals they believe will play important roles in the business. At that point, it may be unclear which individuals will ultimately remain involved as the company grows.

When equity arrangements are not supported by appropriate vesting schedules, employment agreements, or repurchase rights, ownership interests may remain outstanding even after individuals leave the company or cease contributing to its growth.

In addition, diligence may uncover issues such as:

• Missed 83(b) elections
• Improperly issued equity
• Unclear ownership records

Addressing these issues can be complex and time-consuming, particularly when they arise during an active transaction process.

Why These Issues Matter

When structural issues surface during diligence, a company's options can become more limited.

Rather than evaluating opportunities from a position of flexibility, founders may find themselves addressing issues under tighter timelines and increased pressure.

That does not mean every issue will prevent a transaction. However, identifying and addressing potential concerns before a financing, acquisition, or other significant transaction can provide founders with more options and greater flexibility.

Deal Readiness Starts Before a Deal Is on the Table

Valuation often receives significant attention during financing and acquisition discussions. However, the underlying structure of a company can play a critical role in whether a transaction moves forward smoothly.

For founders preparing for growth, financing, or an eventual exit, reviewing capital structure, governance documents, equity arrangements, and related corporate records before a transaction arises may help identify issues early.

To help founders evaluate key areas of concern, we have developed a Deal Readiness Checklist that highlights structural issues businesses should review before a deal is on the line.

➡️ Click here to download the Deal Readiness Checklist today and begin evaluating whether your company is positioned for its next stage of growth.

The information provided in this article is for informational purposes only and does not constitute legal advice. No attorney-client relationship is formed by virtue of this article. For specific legal advice related to your situation, please consult with a qualified attorney.