The Angel Investor’s Guide to Legal Due Diligence

There’s a certain thrill to angel investing that’s hard to replicate. You’re on the front lines of innovation, backing visionary founders, and playing a part in creating something entirely new. The energy is contagious, and it’s easy to get swept up in the excitement of a brilliant idea and a charismatic pitch. But I’ve learned over the years that the most successful investments aren’t just built on vision; they’re built on a solid foundation. And a huge part of that foundation is legal due diligence.

Honestly, the term "legal due diligence" can sound intimidating, like something reserved for high-powered lawyers in corner offices. But at its core, it’s simply the process of verifying a company's claims and assessing any legal risks before you invest. Think of it as the essential homework you do to protect yourself and your capital. It’s about looking past the pitch deck and understanding the reality of the business—its structure, its assets, and its liabilities. Skipping this step is like buying a house without an inspection. You might get lucky, or you might discover a cracked foundation after you’ve already moved in.

This process isn't about trying to kill a deal. It's about going into it with your eyes wide open. A thorough review can uncover red flags, but it can also provide incredible peace of mind. Sometimes, it even reveals strengths you hadn't considered. It transforms you from a passive check-writer into a truly informed partner, ready to add value beyond just the money.

Corporate Structure: The Company’s DNA

Before you dive into the specifics of the product or the market, you have to look at the company itself. How is it structured? Is it a legal entity in good standing? This is the absolute bedrock of your investment. In the US, most tech startups are formed as Delaware C-Corporations, and for good reason. This structure is familiar to venture capitalists and provides a level of governance and stock flexibility that is ideal for scaling and future funding rounds. If the company is an LLC or S-Corp, it’s not necessarily a deal-breaker, but it does mean a potentially costly and complicated conversion will be needed later on.

The first documents you should ask for are the Articles of Incorporation and the company’s bylaws. These are the company's constitution. They outline the basic rules of governance, the classes of stock, and the rights of shareholders. You’ll also want to see proof that the company is in "good standing" in its state of incorporation, which is a simple certificate you can usually pull online. It confirms they are up-to-date on their filings and fees.

Just as important is the capitalization table, or "cap table." This spreadsheet is a map of the company's ownership. It tells you who owns what, how many shares have been issued, how many are reserved for an employee option pool, and what percentage of the company each person or entity holds. A clean, well-organized cap table is a beautiful thing. A messy one, with handshake deals, unrecorded promises of equity, or a confusing structure, is a major red flag. It signals a lack of discipline and can lead to serious disputes down the line that will dilute your investment and complicate future financing.

Intellectual Property: Securing the Crown Jewels

For a vast number of startups, their most valuable asset isn't physical—it's their intellectual property (IP). This could be code, a patented invention, a brand name, or a secret algorithm. As an investor, you need to be absolutely certain that the company owns its IP, free and clear. If they don't, you're investing in an empty shell.

The key document here is the Confidential Information and Invention Assignment Agreement (CIIAA). Every single person who has ever worked for the company, from the founders to the interns to outside contractors, must have signed one. This agreement legally transfers the ownership of any IP they created for the company to the company. I can't stress this enough. I have seen deals fall apart at the last minute because a key engineer who left the company a year prior never signed their CIIAA, creating a cloud over the ownership of the core product.

Beyond assignment agreements, you should also inquire about any patents, trademarks, or copyrights the company has filed or been granted. Verify their status and check for any potential conflicts. It’s also wise to understand if the company’s technology relies on any open-source software. While common, some open-source licenses have "copyleft" provisions that could force the company to make its own proprietary code public, which would be a disaster. This isn't about becoming an IP lawyer, but about asking the right questions to ensure the company's most precious assets are secure.

Contracts, Compliance, and Conflicts

A business is a collection of relationships, and those relationships are governed by contracts. Reviewing a startup's key agreements gives you a real-world look into its health and potential liabilities. You're looking for anything out of the ordinary that could pose a risk to the business's growth or financial stability. This includes customer contracts, supplier agreements, leases, and any loan documents.

Start with the big ones. Are there a few key customers that make up most of the revenue? You need to see those contracts. Do they have long-term commitments, or could they walk away tomorrow? On the flip side, are there any burdensome agreements with suppliers that lock the company into unfavorable terms? Also, take a look at the office lease. You want to make sure there are no hidden clauses or personal guarantees from the founders that could cause problems later.

Finally, you need to ask about any litigation or regulatory issues, past or present. Is the company being sued? Is it under investigation by a government agency? Even a minor lawsuit can be a major distraction and drain on resources. In the same vein, ensure the company is compliant with all relevant industry regulations, especially concerning data privacy (like GDPR or CCPA) if they handle user data. A clean bill of health here is a strong signal of a well-managed and low-risk operation.

A Final Thought on the Process

Going through legal due diligence might feel like you're being overly skeptical or even a bit adversarial, but it's truly one of the most helpful things you can do for a startup. By asking these tough questions, you force a level of discipline and organization that will benefit the company immensely in the long run. You're helping them get their house in order for future investors, partners, and even potential acquirers.

Don't be afraid to ask for help. Engaging a lawyer who specializes in early-stage investments can be invaluable. They know exactly what to look for and can spot issues you might miss. See it as a small cost to protect a much larger investment. At the end of the day, angel investing is a partnership. And the strongest partnerships are built on a foundation of transparency, understanding, and trust—all of which begin with thorough, thoughtful due diligence.