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 in Startup Due Diligence: 5 Reasons it is Critical to the Angel and VC Investor, 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 which 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. This article is part of a series that will examine these issues. We will begin by discussing the general types of information.
Basic Due Diligence Checklist Requirements
Investor Pitch Documents
Investors will be qualifying the entrepreneur and their startup from the initial point of interaction. As a result, the entrepreneur who will be seeking investment should have a prepared cocktail party “one-liner”, an elevator pitch and executive summary available as soon as they realize outside funding will be sought. Presentation materials the entrepreneur should develop include their pitch deck and their business canvas or business plan.
Investors will check the validity of the company by confirming all government filings, such as Articles of Organization / Incorporation, Applications for Employer Identification Numbers, Authorizations to Operate, Assumed Names Requests and Annual Reports have been filed. Startup documents such as Founders and Operating Agreements, Subscription, Shareholders Rights and Convertible Note Purchase Agreements, if applicable, may also be requested. Finally, it is typical for the investor to request various stakeholder tables such as Tables of Shareholders, Option Holders, Warrant Holders, and Debt Holders as well as relevant contact information.
Management & Organization Information
Understanding the company’s structure, its team and their ability to execute is important to investors so they will typically request structural documents such as employee listings, organizational charts, and lists of advisory and board members. Bios and resumes for key players are typically requested as well. Finally, Employment Agreements including NDAs, Non-competes, Non-solicitation and Invention Assignment Agreements should be available on request.
Board of Directors
In addition to a listing of the members of the Board of Directors, their bios and their contact information, investors will desire to review the minutes of previous Board meetings.
As previously mentioned, contact information will be requested for all key players in management, the Board of Advisors and the Board of Directors.
Intellectual property includes all documents related to Patents and know-how, Trademarks, Copyrights and Logos. The appropriated filings and confirmations from the governing agency responsible for the activity are also likely to be requested.
In order to understand the company’s strategic approach, investors will want to review various planning documents including Financial Plans, Marketing Plans, Sales Plans and Technology Plans.
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.
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.
Examples of material contracts which may be requested including Sales Agreements, Supplier Agreements, Joint Development Agreements and Debt Agreements.
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.
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.
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.