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10 points to consider before going through due diligence with a venture capital fund

So your startup has received its first seed stage investment, and you’re now looking to raise a late seed stage or a Series A funding round. In order to ease the due diligence process, your company should be ready to show some documents to the interested private investor or VC fund.

What do venture funds and other professional investors look for when performing a due diligence of your business to decide whether to invest in you startup – or not?
Those investors will first take a look at your business idea, the scalability, the market for your idea, and the team. Your team may not all have experience in your chosen market, but it is always good that they have some related experience before joining your startup.

However, most professional investors and VCs are seeking further, less obvious items – especially once their interest reaches the pre-investment phase and they ask to perform a due diligence of your company.

Below I explore 10 of the more important issues that professional investors usually require in the due diligence process so you can prepare for it.

1) Regulatory concerns and legal aspects

First and most importantly, many professional investors will ask you: Does your business comply with all present regulation? Is every step of the operation legal?

Try to know this answer and give examples according to the regulatory highlights of your sector. If there is any pending legislation, litigation and potential regulatory infringement, or even group lawsuits looming against your business model, at least verify and make sure that the issues will not impact your business model to a point where it will pause it or stop it for good.

Before putting money in your startup, investors will want to ensure that your operation is not endangered due to regulatory issues. Here it is recommended to seek legal counsel.

2) Organisation, formal documentation, and governance

Are your by-laws finalized and complete? Are they known to all shareholders and directors? Are they adequate? Are the minutes of the shareholders or board of directors meetings available?

Can you show the Articles of Incorporation and all the needed authorizations to operate? What about annual reports, social security payment receipts, an organizational chart and shareholders structure?

It is very likely that before pouring funds in your startup, a professional investor will ask you to show him/her your company’s by-laws and meetings minutes in order to grasp your past actions and your capacity for executing and managing under various scenarios.

3) Products / Services

What are the products and services you offer today? What are the products and services you will offer in 6, 12, or 18 months? Do you have a roadmap for their development? Do you know the development resources that will be required to achieve your goals in your portfolio?

What was the cost to develop your portfolio? What is the cost to develop the new products? How much can this cost decrease at scale and with sales that gain volume?

4) Clients

A list of your current clients, the Average Revenue Per User or ARPU, the strategic joint ventures and commercial partners is mandatory. Moreover, having studied the competitors, their strengths and weaknesses, it is always good to have a basic SWOT (Strengths – Weaknesses – Opportunities – Threats) analysis of where you are in your segment and where you want to go.

5) Financial Information

Most investors will ask for at least the current and previous year financial statements. Make sure to have also a basic minimum three years financial forecast. Tax declarations, a detailed list of liabilities, monthly reports and balance sheets may also be required by the interested investor.

6) Verbal is not enough. Go for written contracts and elaborate your standards

A professional investor wants to see that a startup has written and signed contracts. Those contracts can be basic, but should include all important terms and clauses, so that all parties may have reference to their respective liabilities and responsibilities. Those contracts are typically between your company and suppliers, clients, employees, lawyers, accountants, etc.

An experienced investor will likely demand to see the ongoing contracts so that they can understand your business obligations, liabilities, performance and forecasts better.
Be cautious with suppliers, vendors or clients who try to impose one-sided terms in their contracts with your startup. Whenever possible, have your contract standard and suggest that it will be the base for your contract with the other party. When a contract has sensitive clauses in a one-sided manner, this can be a show stopper for an interested qualified investor or VC.

7) Shareholder agreement or Operating agreement

A shareholder agreement is very important, and it is never too much to recall founders, shareholders and first investors to create such an agreement. The absence of a final and signed shareholders’ agreement may block an investment round due to uncertainty of the rights and duties of each shareholder.

What type of shares was given to each shareholder? Who has voting rights? Who doesn’t? Who invested most in the company? Who has put more hours? Who created the business?
Also known as operating agreement by some experts, these documents provide a basis for the commitment of each shareholder. Restriction on shares transfer and sale, anti-dilution provisions, voting arrangements and rights, right of first offer or refusal, compensation clause and an exit clause are usually included.

8) Intellectual Property

Do you know if you are infringing on any third-party intellectual property in your business? Have you already registered your trademark? Did anyone else help creating the intellectual property of your business?

It is essential that there is a clear ownership flow in that intellectual property, with agreements signed with everyone that contributed to the creation of the I.P. of your startup, assigning any potential ownership rights or claims to the company.

9) Development Plans

The more plans you can show to the investor, the better, as they will want to know the future strategy of your startup.

Have in hand at least one basic Financial Plan, a Sales Forecast, Product Development Roadmap and a Marketing Plan.

10) Information Technologies

Information requests related to information technologies developed in-house may include descriptions of software and product development plans. Also, a clear view of what the technology needed and contracted from vendors and technological partners or suppliers should be in that list.

No one can deny that even in a summarised list of 10 items, the due diligence checklist is a lot of work for the founding team. But, even if you are not seeking investment, it is always good to organise your startup as if you were. This can be a powerful incentive to install a minimum core of processes, procedures, documentation and functions in the everyday business operation.

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Bernardo Arnaud
Bernardo Arnaud
Bernardo lives in Vienna and has been consulting and advising companies for 18 years in fintech, commodities trading, telecom assets management, messaging, jobs marketplaces, agribusiness, luxury, e-commerce and SaaS. He founded a few companies throughout his entrepreneurial journey.

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