Which of these statements about due diligence is true?
A. Startup companies should prepare for and ready due diligence items as soon as they open their doors.
B. The due diligence process requires the same information that is used to build and execute the business strategy.
C. Due diligence is an opportunity for entrepreneurs and investors to develop mutual trust.
D. All of the above.
Savvy entrepreneurs know the answer is “d,” all of the above. Due diligence is not simply about legal documents and background checks, it’s the information that puts the opportunity together for potential investors, not to mention customers.
Startup companies should prepare for and ready diligence items as soon as they open their doors.
It’s typical to think of due diligence beginning once investors have expressed a serious interest and intent to invest, but actually, the smart (read: efficient) approach is to gather information and document your current and planned processes or strategies from Day 1. Why?
- Everything is less complex in the early days; there is no history to reconstruct.
- The information that you will eventually need for formal due diligence is the same information you and your management team are using to formulate strategy and build the company, or it should be.
- The structure of due diligence can help entrepreneurs prioritize and focus. Many angel investors are entrepreneurs. They know what it takes to make a startup succeed. That’s what they are looking for when they engage in due diligence. They are not just asking questions as a drill, but rather seeking information that supports the opportunity.
- When an investor does express interest in funding your business, the company will be positioned to move quickly. It’s rare a company raises money when they don’t need it, so shortening the time to funding is often critical.
The due diligence process requires the same information that is used to build and execute the business strategy.
Imagine that your company has attracted the interest of a local angel group. You’ve presented at one of their meetings. One of the angels has stepped up to lead the deal. The group gives you their due diligence checklist.
- Management reference checks and CVs
- Management compensation structure (bonuses/options, current/future)
- Management employment contract
- Customer reference checks
- Client list and pipeline report
- Distribution model
- Business partners
- Intellectual property (IP, patents, applications)
- Board of directors
- Financial statements (historical, YTD, full year plan)
- Financial projections
- Insurance status (liability, BOD, other)
- Employees (working environment, involuntary terminations, attrition and why, pending lawsuits)
- Employment contracts
- Key employees
- Stock option plan
The list might seem long, but there’s nothing here that isn’t an organic part of creating and growing your company. You are already doing these things. If it is not readily accessible, it’s likely the company’s documenting and record-keeping that needs some attention.
Here are some tips:
- Create an electronic “due diligence room.” Cloud platforms like DropBox or SkyDrive make it easy to share when appropriate.
- Digitize all critical documents the day they are created and again on the day they are signed.
- Develop a secure, organized system for filing paper copies that you must keep.
- Ask local angels for their standard due diligence checklist and required documents. Not sure who to ask? We’d be glad to share our checklist.
- Seek advice from your attorney, accountant or CPA.
- Check out the Angel Resource Institute’s feature resource collection on due diligence.
Due diligence is an opportunity for entrepreneur and investors to develop mutual trust.
Angels fund people, not business plans. Due diligence is an opportunity for the entrepreneur and management team to work closely with potential investors as they delve into the details of the business.
It’s a way to really get to know each other and to evaluate, from both perspectives, how it will be to work together if the investment is made.
Entrepreneurs who respond professionally, completely and are receptive to coaching score high with potential investors. Investors who show respect and a willingness to offer constructive suggestions based on experience can be the best thing that ever happens to an entrepreneur.
Due diligence is beneficial and time-consuming for both investors and entrepreneurs. The process helps investors understand the company and mitigate risk while it helps entrepreneurs gain additional perspective on the strengths and weakness of the business.