They’re the two words that can make or break a deal with an investor—the two words that cause even the most seasoned entrepreneurs to grimace:
Make no mistake: due diligence can be stressful. But amidst all the fun and exciting parts of attracting investors to your business—innovating, creating a brand, traveling, pitching ideas, forging new connections—due diligence is always a necessary step. It’s how you build trust with investors. It’s where you show your work.
What Does Due Diligence Mean?
Due diligence is a person or business’s voluntary investigation of another person or business before the two parties enter into an agreement. In the context of a fundraising round, due diligence is an investor’s primary means of learning about the potential opportunities and risks your company presents.
What to Expect from Due Diligence
Expect the unexpected. Every due diligence process is different. The duration and scope of an investor’s due diligence investigation vary depending on factors such as the funding stage, the maturity of your business, and the size of the potential investment, as well as the nature of your company and industry.
An early-stage restaurant, for instance, may have little more for an investor to review than a business plan, a bank account, equipment, and a half-dozen employee contracts.
A medtech company looking for Series B funding, on the other hand, would undergo a rigorous due diligence investigation into its intellectual property, clinical trial outcomes, FDA compliance and approval status, reimbursement structure, non-compete agreements, 5- and 10-year market forecasts, and so forth.
Here’s a sample of the kinds of information and documentation an investor may ask you for:
- organizational charts
- incorporation documents
- income statements
- balance sheets
- cash flow statements
- management reports
- financial projections
- federal and state tax returns
- credit agreements and debts
- customer contracts
- vendor and supplier agreements
- insurance policies
- employee handbooks
- patents, copyrights, and trademarks
- domain names
- lists of real property and equipment
- records of litigation
- court orders
- regulatory notices
Whatever shape it takes, and however long it lasts, due diligence starts after you’ve negotiated a deal, and tends to adhere to the same basic format:
- The investor assembles a due diligence team.
- The due diligence team requests information from you about your company.
- The team visits your organization and conducts an onsite investigation.
- The team interviews your company’s leaders and managers.
- The team prepares a report about their findings.
- The investor considers the report and ultimately decides whether to go through with the investment or not.
How to Make It Through Due Diligence
1. Be prepared. The more organized your documents, the better shape your company will be in for a due diligence investigation. Keep your all of your critical corporate, accounting, HR, and legal information easily accessible and shareable in a centralized location. If you think you don’t have access to all the documents a potential investor may ask for, or you’re not sure, get in touch with your legal and accounting providers as soon as possible.
2. Be flexible. Due diligence can be a long and grueling process. Adjust your expectations accordingly. As our friends at tempCFO write:
“[T]ake the initial estimate of time and double it. It’s a useful conservative approach and helps to make sure you have enough runway to get through the diligence process before funds are transferred to close the investment deal. For some companies it may take 45 days, and for others it can stretch to 3-6 months.”
Keep in mind that due diligence doesn’t put your everyday operations on hold; you will need to continue running your company throughout the process. If you lack the resources or patience to balance both needs—or you’re unwilling to delegate some leadership responsibilities to others on your team—your company’s morale may suffer.
3. Be willing to ask for help. Unlike one-on-one investor pitches, due diligence is a team effort. Consider the accounting, tax, and CFO professionals at inDinero your trusted partners during this challenging period in your company’s lifecycle. Our software and on-demand consultants can help you…
- organize and prepare essential business documents;
- respond to due diligence requests in a timely manner;
- answer investors’ questions using detailed, real-time financial data;
- manage your ongoing tax and accounting obligations;
- and much more.