The Ultimate Guide to Due Diligence for Founders
Due diligence is viewed as an essential part of the investment process. Generally, any investor considering an investment into your company should perform some element of due diligence before a decision is made to invest. The due diligence process is no less important at the early stage investment for any accelerator program than it is at a Series D round, or a potential acquisition opportunity.
What is due diligence?
Due diligence is effectively an investigation and verification process into you and your team, your pitch deck, financial model and corporate entity (in addition to any subsidiary entities). The due diligence process is not of itself an audit or a valuation process, even though it could potentially impact on a valuation. It is effectively a validation process and risk assessment.
SOSV’s Managing Partner, Sean O’Sullivan, succinctly summarises the need for investors to validate a company — and an investment — through due diligence in his popular VC Lingo series.
Before investing into a company, SOSV will conduct an initial due diligence process on your company to ensure that any potential skeletons/problems/issues/concerns are identified and assessed. This initial due diligence exercise will generally focus on areas such as:
- corporate structure
- team
- cap table
- assets (especially intellectual property)
- debt
- litigation
This may sound like an arduous process but, generally, if you have your corporate house in order and have some form of system in place for your records, then due diligence can be an efficient and (relatively) stress free process. In addition, this initial accelerator-format due diligence exercise should give you an indication of what is involved in the process and allow you to build on this for subsequent rounds. Initial due diligence folders established at this early stage can be expanded as necessary as your company progresses and moves on through the different funding stages in the lifecycle of your company.
Due diligence in practice
While the initial due diligence queries may be similar for each team, the actual process will be specifically tailored to each company. By completing the due diligence process, SOSV will be able to address any concerns or clarifications that might result from the process at a very early stage. For example: Why are there changes to your cap table, or why does your company not own all of the IP necessary for its operations? Such questions may be resolved quickly, e.g. a co-founder exited, or the IP is in fact licensed from an institution, or held in a 100% subsidiary entity, but at least the issue has been raised and the position can be clarified. Or perhaps the company has some work to do in certain areas, in which case a decision might be made not to invest, or offer an investment based on certain conditions or requirements to resolve any outstanding issues. In addition to assisting an investor to make an investment decision, the due diligence process will also help you highlight what matters may require attention, correction or amendment which is usually much easier to deal with early in the investment process and company life cycle rather than later.
Due diligence in venture capital
If your investor is a VC fund entity (like SOSV), the due diligence process will also allow for an accurate investment committee (“IC”) memorandum to be prepared. This will allow the relevant investment partner in the fund to bring the potential investment to the IC committee. This is a fundamental element of VC investment and so you need to be prepared to provide as much information to the investor as is necessary to ensure that the relevant “IC Memo” can be prepared, and hopefully approved.
An effective due diligence, clear and efficient communication, and an overall proactive approach can make the onboarding process run exceptionally smoothly with us at SOSV. Ideally, the SOSV investment documents (whether it is an ACE, SPA, FSCA, CLN, etc. https://sosv.com/legal-faq/) must be executed prior to you and your team’s arrival at the relevant SOSV program. This ensures that, once the legal investment process is complete, you and your team can focus 100% on maximising benefit from the program and focusing on, and enabling, further investment.
Due diligence goes both ways
But the due diligence process should not be considered a one-sided matter only. The same process can be applied by you as a founder to a proposed investor, whether SOSV or any other potential investor. At SOSV, we encourage program applicants to engage with us in the process. We can provide you and your team with resources, facilitate on-site visits, and make introductions to relevant contacts, including entrepreneurs from previous SOSV cohorts who can talk to you about their personal experiences.
Conclusion
Due diligence is a key part of securing investment for your company. You need to understand, and be prepared for, the process. In order to maximise your potential for investment, make sure you and your co-founders keep on top of your company records, filings, cap table, IP, etc. and engage with your potential investors and in the due diligence process early.
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