Venture Capital (VC) Investment due diligence process For Startups

30-November-2020 by Virtue Ventures

Venture Capital (VC) Investment due diligence process For Startups

Conducting due diligence on early-stage companies are often particularly challenging as these companies typically have less tangible evidence to show their worth. That is why startups funding is riskier than any other investment for the investor, so to understand and mitigate the same investor mostly prefer to have the process named “Due Diligence”.

Why Due diligence important?

  • Startups are innate risky places for investors to put their money, as many fails before launching.
  • Investors need to be more attentive of the risks they are taking on be placing their money in a startup before making a commitment.
  • Investors, who don’t conduct due diligence before making a commitment can see a low ROI (Return on Investment) or even a total loss of their investment.

What is Financial Due Diligence?

“Due diligence refers to the practice by which each party of a transaction takes steps to verify that each information disclosed by the other party is accurate. Generally, Investors are performing due diligence effectively to audit the company by researching its financial situation, the product, service, or technology, it offers, and any other aspect of a business relevant to them. There are many different ways an investor can perform due diligence.

Timing of VC Due Diligence

Generally, the Financial due diligence process kicks in once startup and your potential investor have agreed on the term sheet. At that point, the investor will present you a venture capital due diligence request list.

Your advance work in preparing your Due Diligence report (“DDR”) will make all the difference at this point. If these investigators have all the investor due diligence documents readily available, the quicker the process will play out.

Normally, due diligence can take some time. If you have your DDR ready with you then, this due diligence time frame can be compressed to weeks instead of months.

Types of Investment Due diligence

Investment due diligence does not have precise formulation, it should be intended to address the particular conditions. The matter which will be examined rely upon structure of contemplated transaction and what investor will get in return for its investment. The matters to be scrutinized also rely upon the stage of development of the investee, business or stage in the financing cycle mention to earlier as “investing scenarios”.

For e.g. in seed funding where business does not yet have grip so that other types of historical information, such as founders background are investigating instead.

Typical steps in Due diligence process will include

Investment due diligence does not have precise formulation, it should be intended to address the particular conditions. The matter which will be examined rely upon structure of contemplated transaction and what investor will get in return for its investment. The matters to be scrutinized also rely upon the stage of development of the investee, business or stage in the financing cycle mention to earlier as “investing scenarios”.

For e.g. in seed funding where business does not yet have grip so that other types of historical information, such as founders background are investigating instead.

Typical steps in Due diligence process will include





Additional types of investment due diligence are technical, environmental and regulatory, performed when the effect of these areas on the business is important. Depending on the situation, the due diligence may need to address very specific topics, as long as they are factors for the valuation and assessment of the risks of the investment opportunity.

What’s covered in the Investment Due Diligence Process?

The startup due diligence process need not be daunting. By following a few simple survival tips, you can ensure that you’re investing in reputable businesses that are positioned to thrive.


Business and Management Analysis

Due diligence of startup must be extensive to indulge all the critical details. Investors must evaluate developing startups from multiple views. There are a few elements that should be evaluated as part of an extensive and effective due diligence process:

  • Investor does comprehensive background verification on your company’s founder, management team and other key work force.
  • The business required analyze the inherent of the business idea, business model and underlying assumption.
  • The market required analyze sales volume, pricing, market prediction etc.

Legal Matters:

This will incorporate each piece of organizational paperwork associated with your organization,

for example, state sales tax license, partnership agreements, articles of incorporation, etc. Legal protections for your intellectual property for your intellectual property patents, licenses, etc.

Financials:

The investor will check your financial history profit and losses budget and projection. You will additionally need to show any business plans and contracts with suppliers and customers.

Employees:

You will be required to show agreement or employment agreements with entirety of your workers to guarantee you have the security of all intellectual property rights.

Technicals:

The investor might need to survey technical information on your product, for example, advance technologies used, and how you address security and versatility issues.

Clients:

Investor may converse with chosen customers to see how well your business is performing and how well it can expect to perform in the future. They also will audit all customer agreements to decide if they support your projections.

Can improper due diligence break your deal?

The answer is “Yes”. Startup investor due diligence costs the investor time and money, so the investor is typically committed to a deal before launching the process.

Still, deals can fall apart during due diligence. Primarily, this occurs because the investor finds the company failed to disclose, whether intentionally or accidentally, which is the value of due diligence.

The process of seeking and gaining venture capital is a fatiguing one that will consume your time and energy. Getting it done successfully, however, means the key to growth and survival of your business and your dream.