Most founders are so laser-focused on convincing investors to invest that they don’t fully consider the due diligence process that comes after. But as the funding landscape becomes tougher, it pays to know what kind of investor you’re dealing with, and how to handle due diligence right from the outset, so that it doesn’t jeopardise your chances of signing a deal.
When it comes to due diligence, investors can vary enormously in their approach. While many VCs are flexible, particularly at an early stage, there are situations where you will face a deeper process, involving specialist external consultants. I’ve found that this is most common amongst venture capital trusts, corporate VCs and government-backed VCs — where the concern of potential litigation is higher — and at late Series A or Series B stage.
Having been through several of these processes with portfolio companies, I’ve seen firsthand the risks involved, due to the time they can suck from the founding team and the business. If you’re not careful, you can come up against delays, or worse, investors pulling out at the last minute. That means your focus shouldn’t only be on passing successfully, but also minimizing the disruption to your team and your business growth.
Here I’ll outline a few tactics that can help to ensure you emerge from deep due diligence unscathed and, crucially, don’t end up back at square one.
Your focus shouldn’t only be on passing successfully, but also minimizing the disruption to your team and your business growth.
Don’t waste time until you have clear commitment
Due diligence is a business cost that can suck up a lot of time. On top of that, by entering this stage you’re giving an investor a certain amount of exclusivity, which means opportunity cost elsewhere. So, before you put any significant resource towards it, you need to have clear commitment from investors.
It isn’t uncommon for big corporates to say they’re interested, sign a term sheet with you along with several other businesses, bring in a team to get educated on your sector and business, and then pull out. Because ultimately they’re the competition.
So, in early discussions you need to get an idea of the certainty of closing, a term sheet on the table, and specifically ask what the conditions are. This will give you an idea of how serious they are, the due diligence you will face, and where you might encounter issues. You need to be assertive, to understand what their offer is and the reasons behind their decision to invest. If you’re satisfied, move ahead. Otherwise, it’s probably not a good use of your time.
Some companies prepare a detailed data room before they even start fundraising, and while it might be helpful to have some of the basics ready to go, everything should ultimately flow from what the investor wants. I’ve seen founders who have prepared an amazing data room and haven’t ended up raising money. Similarly, I’ve seen the opposite situation where a founder hasn’t prepared anything and they have raised. So based on that, my advice would be to wait until you know exactly what they want. You also have confidentiality to consider, so don’t share anything sensitive before you know that an investor is serious.
Manage the scope and timeline
I would also recommend asking for the scope of work at the outset, not only to know what you’re in for, but also to help streamline the requirements as much as possible. For example, if you have audited accounts available, this should cover off a lot of the financial questions. If they’re doing technical diligence, you may want to limit the amount of code you give access to for security purposes. Or if they want to do an HR review, try to control the involvement of the team as that will be a big diversion of time.