Finding the perfect investor in any funding stage can be stressful. You have to create a comprehensive list of potential investors, create a pitch deck with compelling stories and accurate data, and then you actually have to pitch. Once an investor is interested and wants to move on to the next steps, it's time to move on to the next phase of raising funding: due diligence.
You can feel overjoyed when an investor finally says yes, but what comes next is tedious and can be time-consuming if you're not prepared. Although you've given a lot of information in your pitch deck when you've pitched to an investor, they want to know every detail about your startup before handing over their money. It's an essential part of every business deal The better you understand it, the better prepared and more efficiently you can get through it.
This checklist will give you everything you need to survive the due diligence and provide your investor with the information they need to sign over their funding and get started building your startup.
Due diligence is the process that begins when an investor chooses to invest in your startup. They will need to collect more information, such as legal documents, contracts, and financial records, to confirm all facts given in your presentation. For most startup due diligence, the process is completed by the investors to verify the information and better understand every aspect of your startup.
They investigate everything from the team, the tech, the market, and more to ensure they cover any potential investment risks before they move forward. Investors provide a lot of funding, often out of their own pocket. Identifying risks can help them ensure they are making an informed decision.
Investors meet with a lot of founders every year, and each
investor creates a pitch deck full of information designed to
impress the investor and compel them into investing in their
startup. They often can make bold claims about their
performance, market, data, and financials. It's up to the
investors to vet these claims to ensure they are accurate and
get a full picture before they fully invest.
The due diligence process was created to give structure to the investigation process. It details the information needed on the startup so that investors can compare the found information to what was given through the pitch. They have the opportunity to look at any potential legal risks or problems that may impact the startup's future success.
Investors will be incredibly thorough in their analysis of your startup as they look for potential liabilities. They will look into a few key elements further as they complete the due diligence process.
The Market – The viability of your market is just as important as the product itself. Investors like to invest in a startup with a large potential market. They will want to know if your product or service can compete in the current landscape and what you're overall position will be. They will want accurate information on the size of the market and how much of the market you plan to capture. Investors will also need to know your plans for capturing that market. They will ask you, as the founders, to provide this research and likely due a little additional research on their own.
The Product or Service – Whether you're offering a service, a product, an application, or software, they will look into your product to see if it's worth the investment and a real competitor in the market. They will evaluate how your product or service works, how it's manufactured, and how you plan on getting it to your customers.
Who's Involved – Any smart investor will want to know the background of all the founders and employees currently involved in the development of the startup. Investors will look into the background of all the listed founders and current employees. They want to ensure they have the background and experience to do their assigned jobs and do them well to deliver a high-quality product. They want to know if theres a team of driven individuals dedicated to the startup's success before they decide to invest their money.
The Finances – Investors will want to see strong financial growth, profit margins, and good use of the current cash flow of the startup. They will look at every financial aspect of your company and will likely ask questions about using the current funds. They will expect founders to have a good understanding of the money that's come in, where it's going, and what founders plan to do with any money coming in whether it's from income or from investors. A healthy financial profile will signal to investors that you have a level head regarding money and cash flow and that you may be less of a risk to invest in.
Legal Risk – There are a lot of government regulations you need to be aware of as a business owner and ensure you are staying in compliance as you grow your startup. Investors want to limit their liability when searching for a startup to invest in.
Investors will also want to ensure you own all the rights to your property or the intellectual property (IP) and go over any copyrights, patents, pending patents, and more. Any litigation or disputes are a major red flag for investors as they are long, costly, and complex. If you have any issues with IP or disputes within your team, it's better to be upfront with investors in the initial pitching phase to ensure you can foster trust with your investors.
As the process is ongoing and can take months, investors will want to have the answers to many questions as they conduct their research. To ensure you are best prepared for the due diligence process, your best practice is to have all the information that investors look into before the fundraising begins.
Act as if you're an investor and research on your own,
and organize the information into an easy-to-share document
when it's time. Have a checklist ready for the
information you anticipate is going to be required to be able
to respond quickly and professionally. Investors aren't
just investigating your startup. They're investigating
your response and professionalism throughout this process.
They have the right and the ability to back out at any
Assign one person to be the point of contact to make the exchange of information seamless and easy for both parties. Be sure to always answer all questions thoroughly to ensure investors don't have to reach back out for follow-up questions. This process is a great opportunity to build trust and a strong relationship foundation for your investor that is more likely to result in them moving forward with the funding process.
Due diligence can take some time and can last from weeks to
several months. At the end of the due diligence period, the
investor will decide whether to invest in your startup or not.
If the investor decides to invest, you and the other founders
will work with the investors to negotiate a deal to discuss
the terms of how much money they are going to invest and the
equity they will receive based on the information they found
during the due diligence.
If the investor decides they would not like to move forward with the investment, they will let you know and return any confidential information they have found during the startup due diligence.
When an investor is ready to invest, you want to be prepared
for any questions or information they may request. Investors
are already busy individuals, and the startup due diligence
process is lengthy and time-consuming. If they ask for
information and it takes you a while to get back to them,
investors may move on and end up not investing.
If you don't have any information on financials, data on the market, or accurate information, and if you don't divulge details on any potential conflicts, the transaction will likely fall through as investors will see your startup as too much of a risk. Get prepared by understanding everything investors look for during the due diligence and having everything ready ahead of time. With the right preparation and great communication, you'll be able to easily secure funding and build a great relationship with your investors.
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