Due Diligence Demands on the Rise for Entrepreneurs

Due Diligence Demands

As Angels and VCs are tightening their fists, entrepreneurs are less likely to get next stage funding. Having a great team, pitch and front man are simply not enough.

We are on the downslope of a season where valuation of ideas were high and “FOMO” (Fear of Missing Out) was prevalent in the investment community. There are many drivers for this downward change led by the fact that we are seeing a trend of post-market entry, real-world values coming in much lower than even modest projections. In reality, I believe this is a natural market adjustment from the Shark Tank revolution back toward sensible financing standards.

The Resetting of the Startup Industry

As Angels and VCs are tightening their fists, entrepreneurs are less likely to get next stage funding. Having a great team, pitch and front man are simply not enough. Entrepreneurs need to follow-on with a well formed funding packet to meet the due diligence demands of serious investors.

Due diligence requirements and expectations increase at every stage of funding:

Concept Stage – Most investors are stepping away from these opportunities. At this time, your most likely sources of funding are friends and family; nonetheless, entrepreneurs should begin forming their funding package during this time as it will serve as the foundation for future funding rounds.

Seed Stage – The concept begins is now being vetted and if appropriate, validated.  While friends and family are typically still the primary investors, some Angel groups are willing to entertain seed stage investment opportunities. At this point, the funding packet must include actual documentation for your company and include items like:

  • Cost Structures
  • Cap Tables
  • Invention Assignments
  •  Corporate Formation and Structure

Early Stage – Development of the product, infrastructure and team proceed and the company enters the market.  Angel investment is more prevalent at the later points of this stage. The level of due diligence broadens to an entirely new level. Funding packet materials will need to address more than 100 new items, including:

  • Trademarks, Patents and Copyrights
  • Schedule of Logos with Use
  • Loan Agreements
  • Milestones
  • Sales Pipeline
  • Licensing, Leases and Agreements
  • Tax Information

Growth Stage – This stage is appropriately named in that the company is primarily focused on growth in sales. The required capital often comes from angel groups, super angels, angel syndicates and VCs as part of Series A. A great deal of your funding packet has already been created for previous due diligence. In addition to those items, investors will focus in on:

  • Success in Initial Sales Efforts
  • 3rd Party Agreements
  • Insurance Protections
  • Litigation Matters

Mezzanine Stage – Your company is ready to scale. The venture is typically financed in this stage by VCs with a Series A or B round. There are some add-on items to your funding packet during this phase, but the investors focus will be centered on your success to date.

In summary, be prepared to follow-up everything you have learned about impressing investors with a substantive funding packet to meet their stringent due diligence requirements.

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Matthew Cleek

Matthew Cleek is a serial entrepreneur and is a co-founder of FundingSage, which provides valuable information, tools and resources to entrepreneurs seeking to start, grow and fund a business. Matthew’s business ventures include Intellithought, theEclassifieds, Spectrum20, Theme Spectrum and more.