Understanding Due Diligence

So, you’ve found an interested investor. They’ve read your executive summary and heard your pitch. Just when it seems like being funded is in your future, the potential investor begins asking more in-depth questions. Perhaps they ask for a list of references, or more specific details on how you determined your financial projections.

Welcome to due diligence!

You may have heard the term, but unless you’ve actually experienced due diligence, you may not fully understand all it entails. Simply put, it is the evaluation of an opportunity—in this case, your business. Due diligence is performed by investors in order to evaluate risk and protect themselves from making poor investment decisions. Most investors will let you know when the due diligence process has begun. Don’t take offense to this: The fact that an investor is taking an in-depth look at your business is a good sign. It means they are interested.

And while every investor has their own policy for approaching due diligence, there are certain elements you should be prepared to share.

A Thorough Plan
The first way to impress an investor is with your executive summary, so make sure that is thorough, detailed and as up-to-date as possible. Then, even if an investor doesn’t ask for a business plan, you must be prepared to answer any and all data or detail questions including how you determined your market size and trends and what industry data and expense projections you used to predict future financial growth. A potential investor may also request specific documents such as letters of credit, bank statements, policy and procedure manuals, and insurance policies if you haven’t already included these as appendices in your business plan.

Interviews and Reference Checks
Due diligence isn’t just about what you have to say about your business, so prepare a list of references who can speak about your abilities and about the strengths of your management team. The investor will most likely request to interview important leaders in your company, which could include your board of advisors. Finally, prepare a list of customers who are willing to share their experiences with your product. Many investors utilize customer interviews to get a better understanding of your product/service and to gauge current customer satisfaction.

An In-Person Presentation
If you haven’t already given a demonstration of your technology, a potential investor will likely request one during due diligence. This is another chance to reinforce your company as a great investment opportunity. It also gives the investor a chance to ask questions and see the passion you have for making your business successful—something that does not always register over the phone or on paper. It’s important to note that investors often feel they are not just investing in a technology or a company, but in its leadership as well. It goes without saying that you and your team should be prepared to put your best foot forward and show the investor that you are capable of generating a return on their investment.

A Tour of the Business
If you’re already up and running, some investors will request a tour of your business. This is a quick way for them to evaluate the legitimacy of your company and directly shake hands with members of your staff. Make sure your management team and employees know when a potential investor will be visiting. It’s likely that an investor may want to speak directly with them to judge your hiring and managing abilities. They also want to make sure that your employees are as passionate about the business as you are.

Direct Answers
Throughout this process, the investor will no doubt have many direct questions about you and your business. They simply want the facts, so make sure you give them direct answers. They don’t expect you to be perfect. Most new businesses, and even established ones, have a few skeletons in their closet, whether they are in the form of a past deal that fell through, a relationship that went wrong or a business strategy that didn’t pan out. Don’t just tell the investor what you think they want to hear. It’s better to be straightforward than to have the investor find out later in the due diligence process that you haven’t been completely honest in your assessment of things. Losing credibility with an investor is the quickest way to end a potential deal.

Finally, due diligence isn’t just for investors. As an entrepreneur, you should always be aware of who you conduct business with. Getting involved with an investor is a long-term commitment. While you need capital to grow your business, you also want to make sure you are involving people who want the same things for the company’s future.

For more useful tips on getting your venture started the right way, check out JumpStart’s helpful Entrepreneur Toolkit. And don’t forget to sign up for JumpStart for Entrepreneurs, our monthly newsletter giving you more helpful advice along with local success stories and lists of local funding/networking opportunities.