For most startups and small businesses, due diligence is a mandatory task where a potential investor goes through a vetting process before committing to investing in your company. The intensity of this review often depends on the amount of investment involved. This should be clear to any viewer of the business reality TV shows Dragon’s Den in the UK or Shark Tank in the US.
Accuracy and transparency are essential
Sometimes due diligence can be as simple as a face-to-face meeting, especially if you are a start-up looking for pre-financing. Typically the process involves business lawyers, accountants and a lot of paperwork. Honesty and integrity as well as accuracy and transparency are of utmost importance as the goal of due diligence is to reduce risk. Everything you say must match the data you provide because the truth will always come out in the end. Err on the side of disclosure.
Preparing for due diligence is a great opportunity to conduct an internal audit and review the growth plan that will form a significant part of your pitch. Proper preparation will also allow you to focus on day-to-day operations and gain an up-to-date overview of your business, which can reveal areas worth optimizing, even before the investor intervenes.
What investors will ask
Typically, investors must go through a standardized checklist, although every investor is likely to have different questions. Enlisting the help of business and legal advisors like Motion Paradox can make due diligence easier by preparing all the common documents that investors typically need in advance. Given the sensitivity of the data you disclose, it is common practice to enter into a confidentiality agreement with the potential investor, although the effectiveness of these agreements is questionable.
Your business plan and financial records are the most common data points investors ask about. The goal of reviewing this information is to make sure your pitch fits the actual numbers and doesn’t burden you with debt. Start-ups often have several co-founders. Therefore, ensure that any documents detailing your ownership structure are up to date and ideally include a credible contingency plan for disagreements if there is 50/50 equity between the founders. Angel investors and venture capitalists (VC) will also likely insist on seeing properly prepared transcripts of stakeholder or leadership meetings and receiving complete candor about any legal issues you may face, whether pending or impending.
Customer data, sales revenue and market knowledge
Investors want to learn more about your customer base and supply chain, as well as understand your revenue streams, cost per customer acquisition, and pipeline forecasts. As part of the due diligence process, investors will likely conduct an intensive review of your competitors and general market conditions. Therefore, make sure you can answer any questions a potential backer may have to demonstrate your understanding of the area you are in and the way you operate Can prove you fit in there.
Make sure contracts are watertight
Your existing employment contracts, customer contracts and supplier contracts will all likely be a crucial part of any due diligence review. Many start-ups and SMEs create contracts without expert guidance, relying on templates from the internet or what they perceive as “common practice”. A serious potential investor will quickly determine whether these standard contracts actually protect your company and therefore their investment and are sustainable in the long term. They will view your business much more positively if you have tailored contracts and services in place as, from their perspective, this mitigates any risk and helps you scale properly.
Intellectual Property Rights
Potential investors should take a look at your intellectual property (IP) rights. So if you haven’t already done so, file all patents and trademarks before complying. Your IP rights are a key economic differentiator for investors, especially for technology start-ups. Even if you have a really great app or product without any IP protection (patent information, copyrights, design rights, trademarks), they will argue that a tech giant could offer the same thing for free on a large scale. So why should they bother investing in something? You?
Personal interviews
If you ask anyone in business, they’ll probably say that people tend to do business with other people. So even if all the numbers add up, the success of your business depends on you and your team. As part of the due diligence, both your company and you personally will likely be scrutinized. Potential investors may want to speak with you and your team individually to get an idea of their personalities, values and skills.
Set up a data room
You can get a head start on attracting investment by setting up a data room to streamline the due diligence process and put all the information most investors are likely to want to see in one convenient place — short presentation, team background, Business and marketing plan, details of contracts and software licenses, financial statements and intellectual property assets. Virtual data rooms are now the norm, but whichever cloud sharing/hosting platforms you choose, you should ensure that they offer both easy access and high levels of encryption and security, as much of the information that You place them there, are business sensitive and confidential.
Investors in start-up companies in particular are likely to initially propose a term sheet. Term sheets are agreements that outline the key elements of the investment transaction. Although they are not legally binding, it is still important to have access to sound legal and business advice at this stage of any negotiation. After an investor proposes a term sheet, they must review all of your information to make sure what you are selling them is genuine. A well-constructed data room conveniently provides them with all the details and confidence they need.
Motion Paradox’s team of start-up companies and legal advisors based in London and Los Angeles can assist you with due diligence, provide informed feedback on your completed plans, prepare tailored contracts and secure your IP assets You can convince VC or angel investors to support your vision.
