David S. Rose, the CEO of Gust and Founder of the New York Angels defines Due Diligence in his book, Angel Investing – The Gust GUIDE TO Making Money and Having Fun Investing in Startups. The careful investigation into a company prior to making an investment.
This definition provides the essence of the subject. But, that’s just the beginning of a long journey undertaken by the entrepreneur!
As I note experienced entrepreneurs recognize that they are preparing for investor scrutiny from the very beginning, even at the concept stage. They establish a due diligence checklist that supports the development and growth of an investable company. In order to begin that process, the entrepreneur must know what the investors will request and the reasons they are requesting it.
Basic Due Diligence Checklist Requirements: (Continuing the list)
8. Products / Services.
If the product or service has not been developed, investor questions will include issues related to the technologies, skills required for development and related risks. If it has been developed, investors will require you to provide details related to your product or service such as the cost of development and estimated manufacturing cost at scale.
9. Customers & Clients.
Key customer lists with contact information, press releases, and lists of the competition with summaries of their strengths and weaknesses are examples of customer and client information that may potentially be requested by investors.
10. Material Contracts.
Examples of material contracts that may be requested including Sales Agreements, Supplier Agreements, Joint Development Agreements, and Debt Agreements.
11. Financial Information.
Current and previous year financial statements, federal, state and local income taxes, insurance policies, cap tables, lists of liabilities and accounting methodologies are a few of the key pieces of financial data that may be requested.
12. Information Technologies.
Requests related to information technologies will likely include descriptions of internally developed software, product development road-maps, production stacks and details related to any contracted partners.
Environmental documentation may not be applicable. However, if it is, entrepreneurs should expect requests for hazardous substance listings, descriptions of hazmat disposal methods and copies of environmental permits and licenses.
14. Legal Information.
Investors will have a keen interest in legal opinions received, pending or potential litigation, discussions with regulatory and other government agencies and licenses, permits and consents.
As we can see, this due diligence checklist is extensive. The only way to address the due diligence needs of investors is to accomplish them over time as you negotiate through your startup journey. This requires that they are completed during the development and growth of the company. Those entrepreneurs not recognizing the need for this due diligence decrease their chances of obtaining funding from Angel and VC investors.