When you look at the words Due Diligence, startup founders seeking funding shudder just a little bit, especially if they live on the creative side of things. Because due diligence is a little bit scary. It’s like stripping down in front of the doctor for a physical exam. You know you have to do it, but there’s always a little bit of anxiety over what he might find.
When you are seeking funding, the due diligence phase is when you are going to show the investors everything behind the business. Because they need to see several things to establish trust:
- You’re responsible with money and property.
- You keep accurate records of what has happened before.
- You have a plan for tomorrow.
- Your plans include things like market and personnel changes and contingency plans for each.
- You have a plan to bring your idea to market and keep it top of mind with your audience.
A good VC will dig into everything. What does that look like, and what should you be ready for?
Show Me the Money, All of It.
Okay, first and foremost, the venture capitalist or angel wants to know all about your financial position, and what it has been for the last three years or so. They also want to see projections of what you expect your finances to look like going forward.
This means all taxes, income, and cashflow statements, profit, and loss statements, and all recent activity year to date as well. They will look not only at your company, but they will look at you, the founder as well.
You’ll need to provide your personal taxes and in some cases, the investor will do a credit check too. After all, if you don’t handle your personal finances well, why would they want to trust you with their money? Venture capitalists are looking for a payout, and that means they will want to see a future plan to create that payout. You must handle your finances well for that to happen.
Be prepared, and if you have questions, have your accountant help you. It will be worth any expense so that your investors get the best information in the greatest detail possible. Be nimble and ready to answer inquiries as they come.
When preparing for due diligence, it is important to gather all records you have into a central location. Fortunately today that does not mean gathering a whole bunch of boxes into a conference room. Typically it means gathering them in a secure data room where they can be easily accessed while still being encrypted and protected from those you don’t want to have access.
You‘ll need all of these things handy:
- Anything to do with your board or other governing body.
- Shareholder record and minutes
- Press releases
- Organizational charts.
Essentially you will need any records that have to do with anything you have done in the course of conducting business that you can possibly see a venture capitalist being interested in. Again being nimble is the key. If you are asked for any kind of records, being able to produce them promptly will not only speed the process but will build investor confidence and trust.
No, not your security guard in the lobby, but any records you have related to securities will be examined. Shareholders, members, books and ledgers, options, capitalization, certain agreements, and other information will all be required. The more thorough you are in preparing this information, the easier due diligence will be.
You will have to reveal any inside transactions, and this includes any payments, dividends, or payments from directors, members, shareholders, and anyone who is a company insider. This also includes any bankruptcy any company insider might have been involved in either personally or with another company or organization.
It’s not only the founder’s finances that matter, but anyone who will be managing or directing the use of investors’ money. Integrity is a must at this stage and all stages. The motto of due diligence is simply this: disclose, disclose, disclose.
Debt and Credits
Again, the venture capitalist or angel will want to see all of your debts. This means that even if they are not public record, you must disclose them. This includes things as simple as payments you might be making on company vehicles to other financed business equipment the company uses.
Not only do you need to have a list of debts, but you should also have a debt schedule and financing arrangements. How will you pay off debt? How soon? What is the impact of that debt on your bottom line?
What you are financing also matters. Inventory should rarely (read never) be financed except in extremely unusual circumstances. You’ll also want to reveal if the company has made any loans to directors or other insiders, or to employees. This should include their plans to repay those loans and don’t be surprised if your VC wants to perform a credit check on those individuals as well.
Your company likely has commitments, whether that is to a vendor or a customer or for development under a joint venture. You may also have distribution agreements and other commitments in place.
You need to reveal all of these during due diligence. The VC may have a preferred distributor for your type of industry while other agreements may reassure them of the potential of your concept. Either way, you need to show what you are committed to, for how long, and what that means to your company operations.
What do you own? This includes any real property that could be considered an asset. Mortgages, liens, leases, and any other documentation related to assets, even if they are not located on the primary company property should be documented and reported.
Remember, disclose, disclose, disclose. If you don’t reveal a lien or lease and the investors discover it in the process of due diligence, they will understandably ask some questions, and this kind of non-disclosure can often be a deal killer. Be thorough.
Moats and Keeps
What do we mean by moats and keeps? What intellectual property, copyrights, patents, and other items do you have that set you apart from your competition and are protected? What about licensing and confidentiality agreements? Everything will be fair game, and rightfully so.
One of the worst things that could happen is for a VC to fund you, and then for your idea to be stolen because it was not protected properly. Investors want to be reassured that won’t happen.
You have to get your product or service noticed, and investors not only want to know that you do have a plan, but they also want to know what it is. Before you seek funding, you need to have a robust GTM strategy, know your target audience, and know how and where to reach them. You’ll need to share your records from the last three years.
Also, you will also need to show the results of that marketing. You need to show sales from the last three years, preferably with growth, and where and how those sales came about. This includes geography, demographics, top customers by spend, and projected CAC and CLV figures.
A great product doesn’t do anyone any good if you don’t have a way to market and sell it, and if you can’t be successful at that part of your business.
From executives and executive benefits to your entry-level employees, you need to share all these records with your investors. They will want to know who is paid what and when, benefit packages, perks, and more.
They’ll also want to know other things about your employees. How long have they been your employees? How loyal are they? How long can they be expected to stay? Are there contracts and bonuses they should know about?
As the Apple motto says, “Our people are our business,” so are yours. Investors must understand the “who” that makes up your company.
Can You Dig It?
Does this seem like a lot? It is. When it comes to due diligence, think of the old phrase, “Can you dig it?” If there is a record, statistic, financial document, number that can be dug up, it will be. Due diligence goes beyond the public record to the investors getting to know your company in every intimate detail.
What can you expect when it comes to due diligence? Perhaps the most comprehensive physical your company has ever had. The more prepared you are, the smoother the process will go. And remember, if you disclose everything at the start, you’ll earn trust, ease the stress of the process, and make yourself and your company even more desirable investments.