A potential investor has said that they will perform due diligence on my start-up before putting up the money. What kinds of things are they entitled to know and how can I prepare for this?
The process of due diligence (or DD) is a lot like the mythical “ball of string”. It can take as long, be as complex and as expensive as you and your potential investor allow it to be.
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Your investor is “entitled” to know as much he or she needs to know to make an informed decision, and as much as you are willing and able to share.
All commercial transactions require some level of DD and the goal for a start-up company should be to keep DD to a reasonable level. You will achieve this by following a fairly strict plan.
1) Set the scope of the DD
Agree with your investor on what issues will be part of the DD. Typical DD categories in the start-up phase would be:
- Corporate structure chart.
- Listing of business names and URLs registered.
- Copy of company details from relevant government company records.
- Listing of directors and officers for the company.
- List of investments in other companies or businesses.
- List of shareholders indicating number of shares and class of shares.
Annual / Statutory Reporting
- Latest annual/statutory financial statements.
- Latest tax returns.
- Organisational chart of employees.
- Details of any bonus schemes/deferred compensation schemes.
Legal & Related Parties
- Details of any litigation or material disputes as yet unresolved.
- Details of any material related party transactions or agreements.
- Historical profit and loss statements and forecasts.
- Balance sheets.
- Capital expenditure plans.
- Cashflow forecasts.
2) Agree a timeframe for your DD process
To reduce the expense and impact on your business, set a deadline for the DD process. For a start-up company this should be less than 20 working days.
3) Agree who will be working on the DD process; sign NDAs
On your side it might be your accountant, lawyer and IT person and on their side it might be their accountant and lawyer. Keep the group who have access to your data tight, and make sure non-disclosure agreements are signed.
4) Prepare for DD
To make the process smooth and efficient, start collecting the above documents and data in an online data room that you can set up in DropBox or BoxNet.
You can then grant certain people access to some or all of the data and track their activities. Make sure you number and name each document in a methodical way so you can find it and refer to it.
Keep this DD data up-to-date for as long as you run the business, as you will need it for the next round of investment, or for your eventual successful exit!