What is Due Diligence and why should an entrepreneur care?

By J. R. Rose

Due Diligence, according to Merriam-Webster dictionary is defined as:

“Research and analysis of a company or organization done in preparation for a business transaction.” 

In this case, it is the research and analysis of entrepreneurs and their early stage companies in preparation of an angel investor opening up their checkbook , giving you money, and becoming an owner of your startup dream.  Kicking the tires so to speak or maybe dating before getting married (cutting a check).

The Due Diligence process will quickly become serious dating with a pre-nep agreement before it is all over.  The angel investor will become a part owner of your company and before they do that they are going to want to know almost as much as you do about it and the team behind it.  Due Diligence is NOT a 10,000 foot flyover of your company but a deep-dive down in the weeds to review and analyze.  They will be searching for reasons why to invest along with any and all the risks which may be associated with an investment in your company.  They will be looking closely at you and your team to determine if it is a good fit with what they are looking for in an investment.

That being said, you’ll need to open up your books to them.  Share your inception-to-date successes AND failures and any pivots you’ve made and why.  This deep dive by potential investors typically includes reviewing and understanding the following aspects of your business:

This maybe a pretty scary list for some entrepreneurs to swallow, especially if they have a few skeletons in the closet.  However, the only way to proceed is with full honesty and transparency.  Eventually the investors will find any skeletons and if they find something which you didn’t disclose you’ve shot yourself in the foot and all trust will have been thrown out the window.  [note: angel investors talk among themselves and if you hide something and they find it they’ll share this info with other angel investors in their network and you’ll be essentially blackballed)  Angel investors are typically smart and savvy, they can accept a few skeletons if they are disclosed and you explain how you overcame the problem and what you’ve done to insure it won’t happen again.  They are looking primarily at what productive things their monies will be used toward going forward into the future success of the company, not what’s happened in the past. 

The Due Diligence process WILL disrupt current operations and initiatives so beware and plan ahead.  Start collecting documents from day one.  Scan all legal and tax filings into an electronic file, also scan all major vendor and customer contracts into another file, update financial projections prior to beginning to search for capital, make sure your cap table is kept entirely up to date, and document all reasons you missed your original projections either positively or negatively.  Have you undergone a major pivot prior to your original business plan?  Capture the why, what, and how and document it that so you don’t have to try to remember why you did at a later date.

The Due Diligence undertaking can be long and arduous, however, being prepared and knowing what to expect can take a lot of the frustration and stress out of the process.  So be prepared to open up the books, the files, and your minds and show those interested investors that you’ve got nothing to hide and that you will bend over backwards to accommodate them during this process.  The less effort the investor has to put forth to get the answers to their questions the more apt they are to loosen up their pocketbooks and become co-owners of your business.