What do investors check in due diligence?

What due diligence is for

Due diligence is the investor’s check that the company is what you say it is. At seed it’s usually lighter than at a Series A, but the questions are the same: who owns the company, does it own its product, and is anything likely to cost money or stop a sale later?

It usually starts after a term sheet is signed, with a request list and access to a data room. The investor’s lawyers then send follow-up questions, and anything they find can turn into a closing condition in the share subscription agreement.

Corporate records and the minute book

Investors start with the minute book. Both corporate statutes require a corporation to keep certain records, including its articles, by-laws, minutes and resolutions, and registers of directors and securities (section 20 of the CBCA, section 140 of the Ontario Business Corporations Act).

They’ll check:

• Articles and by-laws, including the share classes and any restrictions on transfer.
• Resolutions approving every share issuance, director appointment and major decision.
• The securities register, which should match the cap table exactly.
• The register of individuals with significant control. Federal corporations must keep one under section 21.1 of the CBCA and, since January 22, 2024, file the information with Corporations Canada each year with their annual return and within 15 days of a change. Ontario corporations keep one under section 140.2 of the OBCA.
• Annual returns filed with Corporations Canada or through the Ontario Business Registry. Missed returns can, over time, lead to a corporation being dissolved.

If the company was incorporated quickly online, the organizational resolutions and first share issuances are often missing. That’s fixable with ratifying resolutions, but it takes time. See should I incorporate federally or in Ontario?

The cap table and earlier financings

The cap table is where small errors become expensive. Investors check that every share, option, SAFE and convertible note on it is backed by a signed document and a board approval, and that the numbers reconcile.

For earlier rounds, they’ll also look at securities compliance. Each SAFE or share issuance needs a prospectus exemption. If the company relied on the accredited investor exemption, section 6.1 of National Instrument 45-106 required a report of exempt distribution within 10 days. Missing filings can usually be made late, with late fees. See how SAFEs work in Canada.

They’ll also model how outstanding SAFEs and notes convert, and check any side letters giving earlier investors extra rights such as pro rata rights or an MFN.

Founder arrangements

Investors want to know the team is committed and the equity is settled:

• A signed shareholder agreement, and how it changes on the new round.
• Whether founder shares vest, and what happens if a founder leaves. See founder vesting.
• Any former cofounder or early contributor who was promised equity. These claims are easier to settle before a round than during one.

Intellectual property

For an AI or SaaS company, this is often the most important section. Under section 13 of the Copyright Act, the author of code is generally its first owner unless they made it as an employee in the course of employment, and an assignment must be in writing and signed. So investors usually ask for:

• an IP assignment and moral rights waiver from every founder, including for work done before incorporation;
• assignments from every contractor, agency and freelancer who touched the product;
• a list of open source components and their licences;
• for AI products, where training data came from and what rights you have in it;
• registered or pending trademarks for the company and product names.

See who owns code a contractor writes and run our who owns your code check. For AI data questions, see AI training data and web scraping in Canada.

Customer and supplier contracts

Investors read your material contracts for terms that could limit growth or a sale:

• assignment and change of control clauses that need customer consent;
• exclusivity or most favoured customer pricing;
• uncapped liability or broad indemnities;
• data processing commitments you may not be meeting.

A consistent SaaS agreement makes this a short review. Dozens of different customer papers make it a long one.

Employees and contractors

They’ll check that employees have written agreements with confidentiality, IP and termination clauses that comply with Ontario’s Employment Standards Act, 2000, that contractors really are contractors, and that option grants were made under a properly adopted plan. See employee or contractor and option plans for startups.

Privacy, regulatory and tax

Expect questions about your privacy policy and whether it matches what the product does, any privacy breaches and how you handled them, CASL consent for your email lists, and any sector rules (health data, financial services). On tax, investors may ask about CCPC status and SR&ED claims, because the round itself can affect both.

How to prepare

1. Build the data room before you need it. Organize it by the headings above.
2. Reconcile the cap table to the securities register and every signed document.
3. Fill the gaps: ratifying resolutions, missing share certificates or registers, confirmatory IP assignments, late securities filings, overdue annual returns.
4. Write a short disclosure list of known issues. Telling investors first usually lands better than having their lawyers find it.
5. Keep it current. A data room maintained after each hire and contract is much easier than one rebuilt before each round.

Our investor due diligence prep reviews your corporate records and cap table and gives you a list of gaps and fixes, starting at $1,480; see the fees page and raising money. For timing, see legal help for AI and SaaS startups, stage by stage.

This guide is general information about Ontario and Canadian law, not legal advice for your situation. To talk about your round, book a free 15-minute consult.