Don’t Get a Face Tattoo: 5 Things That Will Inhibit an Exit | Pillsbury – Propel
In an M&A process, certain problems stand out like a face tattoo: visible from the first glance, shaping every impression a buyer forms. Buyers form early views from your capitalization table, minute book, IP chain of title, compensation programs and contract files. If those materials reveal avoidable risk, sellers will pay for it through a reduced purchase price, extended diligence, or both.
Below are five recurring issues that can stall M&A processes, together with practical steps to remediate them.
I. Messy Capitalization
Diligence red flags
Capitalization problems are among the first—and most damaging—issues uncovered in M&A diligence. Over-issuances of stock, SAFEs or convertible notes with inconsistent or overlapping terms, and incomplete corporate records supporting equity issuances create uncertainty about ultimate ownership and raise the risk of rescission claims or purchase price disputes. For a buyer, these errors cast doubt on whether they are acquiring the entire company, slow the diligence process and may require price adjustments, holdbacks or additional indemnification to get the deal closed.
Capitalization problems are among the first—and most damaging—issues uncovered in M&A diligence. Over-issuances of stock, SAFEs or convertible notes with inconsistent or overlapping terms, and incomplete corporate records supporting equity issuances create uncertainty about ultimate ownership and raise the risk of rescission claims or purchase price disputes. For a buyer, these errors cast doubt on whether they are acquiring the entire company, slow the diligence process and may require price adjustments, holdbacks or additional indemnification to get the deal closed.
Buyer-ready standards
- Reconciled records: The stock ledger and cap table align precisely with every entry (founder stock, preferred stock, options, warrants, SAFEs, notes) supported by fully executed, dated documentation and corresponding board and stockholder approvals.
- Clear conversion mechanics: All valuation caps, discounts and pre-/post-money mechanics are clearly specified.
- Remediation completed pre-LOI: Legacy errors are resolved before diligence begins—through ratifications of defective grants, corrections to the ledger, or harmonization of inconsistent SAFE/convertible note terms—so they do not become leverage points late in the process.
- Compliance register: All securities law filings (Form D, state “blue sky” notices and other required submissions) are organized in a simple register to confirm compliance.
II. Corporate Formalities Not in Order
Diligence red flags
Disorganized minute books, missing foundational documents, absent approvals for issuances, and failures to properly record director and officer appointments all raise governance concerns that buyers view as risks likely to cause post-closing complications.
Disorganized minute books, missing foundational documents, absent approvals for issuances, and failures to properly record director and officer appointments all raise governance concerns that buyers view as risks likely to cause post-closing complications.
Buyer-ready standards
- A complete post-incorporation set: bylaws, initial written consents, founder stock purchase agreements (with timely 83(b) filings where applicable) and a compilation of fully executed resolutions.
- Good standing in each operating state: foreign qualifications and registered agents in place; franchise/annual reports current.
- Ensuring all security issuances are properly documented and issued shares don’t exceed authorized shares.
- Maintaining accessible, clear records of director and officer appointments and resignations.
- Pre-LOI spotting, correcting and ratifying any corporate formality gaps.
Helpful Propel reads:
III. IP Not Properly Assigned (Chain of Title Gaps)
Diligence red flags
Failure to assign pre-formation Intellectual Property (IP), contractors building core code without written agreements, employee side projects overlapping with the company’s product scope, and joint development arrangements with unclear ownership or prosecution responsibilities all create uncertainty for the buyer.
Failure to assign pre-formation Intellectual Property (IP), contractors building core code without written agreements, employee side projects overlapping with the company’s product scope, and joint development arrangements with unclear ownership or prosecution responsibilities all create uncertainty for the buyer.
Buyer-ready standards
- Present-tense assignment: Every founder/employee signs a PIIA with “hereby assigns” language; contractor agreements include present-tense assignment and work-for-hire language.
- Pre-company IP has been assigned (for equity or cash), with written confirmations of no prior employer or university claims; domain names, social handles and repositories are owned by the company account.
- Ownership confirmed and maintained: The company maintains clear records establishing ownership of all patents, trademarks, copyrights and trade secrets, together with current registrations, assignments and renewals to ensure continuity of rights.
- Ongoing IP governance: Processes are in place to monitor deadlines (e.g., maintenance fees, renewals, prosecution timelines), control access to trade secrets and ensure that any new IP created by employees or contractors is promptly documented and assigned to the company.
IV. Executive Compensation and Benefits Missteps
Diligence red flags
Improper option grants, 409A valuation gaps, unclear change in control acceleration terms, and poor benefits administration or wage and hour classification all surface in diligence as risks that can result in penalties (including tax), unwelcome renegotiations, or both for the buyer running the business post-closing.
Improper option grants, 409A valuation gaps, unclear change in control acceleration terms, and poor benefits administration or wage and hour classification all surface in diligence as risks that can result in penalties (including tax), unwelcome renegotiations, or both for the buyer running the business post-closing.
Buyer-ready standards
- 409A discipline: an independent safe-harbor valuation within the past 12 months and refreshed after material events; no in-the-money options at grant.
- Complete equity files: board approvals, grant notices, vesting, early-exercise/repurchase terms and (where applicable) timely 83(b) filings.
- Market-standard change-in-control protection: typically double-trigger, consistently applied; single-trigger benefits, if any, are documented, limited and disclosed.
- Wage and hour classification: employee and contractor classifications are reviewed and compliant with applicable wage and hour laws. Non-exempt employees are properly tracked for overtime; exempt classifications are documented and defensible; and independent contractor arrangements are vetted to avoid misclassification. Records of hours, wages and benefits are organized and current.
V. Contracts and Diligence Materials Aren’t “Dataroom-Ready”
Diligence red flags
Buyers expect contracts and diligence materials to be complete, organized and free of problematic terms, Missing agreements, untracked amendments or sticky provisions (exclusivity, MFNs, change-of-control consents) slow down the process and reduce leverage. Even strong companies lose weeks when they cannot produce complete records or discover problematic terms too late in the process.
Buyers expect contracts and diligence materials to be complete, organized and free of problematic terms, Missing agreements, untracked amendments or sticky provisions (exclusivity, MFNs, change-of-control consents) slow down the process and reduce leverage. Even strong companies lose weeks when they cannot produce complete records or discover problematic terms too late in the process.
Buyer-ready standards
- Dataroom architecture that mirrors disclosure schedules: corporate, cap table, litigation, material contracts (customers/suppliers), IP, employees/benefits, privacy/security, regulatory. Use consistent naming (e.g., counterparty – agreement type – date – status).
- A living Top-10 list of customers and vendors with revenue thresholds, renewal and termination mechanics, and any dependency risks.
- Having in place a process to review contracts before they are entered so that MFN, exclusivity, change of control and other potential problematic provisions are tracked and monitored.
Bottom line
Diligence rewards visible discipline: reconciled equity, coherent governance, documented IP ownership, well-administered compensation programs and contracts a buyer can review without caveat. Engaging experienced outside counsel for a targeted pre-diligence review—covering the cap table, corporate records, IP chain of title, compensation and material contracts—helps identify and remediate issues early, reducing execution risk, cycle time and pricing uncertainty on your prospective M&A deal.
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