Guide to Fundraising Due Diligence
This article will guide you on how to prepare for fundraising due diligence.
You’ve found an interested investor as you seek funding for your new business. The process has been successful so far, but there is still a way to go before the funds are deposited into your account. Your business must first pass due diligence, the in-depth analysis backers must do to verify or refute your representations about its foundation. As a founder, you must be aware of the importance of fundraising due diligence for your startup. But how does it really work? What is the time frame? What, then, are some potential stumbling blocks for a young company? This article will guide you on how to prepare for fundraising due diligence.
Fundraising due diligence
If you’re a startup owner seeking funding, you should be ready to provide the information necessary for investors in equity like venture capital firms and angel funding to complete their due diligence, verify that your company meets their investment criteria, and investigate any investment risks. Let’s understand more about the fundraising due diligence process in this section.
What is fundraising due diligence?
All the investigation a potential investor does before deciding whether or not to finance a business is called fundraising due diligence. Its purpose is to give back-up for the founder’s claims and enables potential investors to determine if they can bring value to the company beyond financial means. Although formally it may begin when a creator and an investor begin discussing raising capital, in practice it begins much earlier, during the first interaction between the two.
How does fundraising due diligence work?
Investors, typically business angels or venture capital funds, perform due diligence as part of the funding process to verify information stipulated in the startup’s pitch deck and assess business and market prospects, financial reports and forecasts, legal documents, and various risks. In a nutshell, the purpose of fundraising due diligence at a startup is to reassure backers that the business and its leaders are good bets.
The process of doing due diligence on a company varies from investor to investor. Venture capital firms thoroughly investigate potential investments, whereas business angels tend to undertake just a cursory check. In this regard, remember that completing a funding round via a VC firm would include a stringent screening process.
That’s why it’s crucial for startups to be completely forthright in their pitch deck and any other documentation they submit during the fundraising process. As a result of the rapid pace of agreements made during the early phases of a startup’s development, an increasing number of VC funds have shifted their focus to providing just basic business evaluation, which is excellent news for entrepreneurs.
Importance of fundraising due diligence
Startups might gain from the due diligence process even if it is conducted to protect the interests of investors. Experts evaluate companies thoroughly to identify their best and worst qualities; this helps businesses focus their efforts where they will have the most impact. Here is a list of why fundraising due diligence is crucial for your business.
- A startup’s assumptions are challenged through due diligence, which might reveal flaws in the company’s strategy, its products, or its financial projections.
- Founders of new businesses often don’t react positively when they make an important discovery. But with their help, you will not only be able to identify the weaknesses in your business but you will also be given clear guidance on how to fix them.
- Even if the potential investor backs out of the agreement, the work spent on the verification report will have paid off in the end.
- Furthermore, investors’ commitment to your company and belief in its potential will be shown by their willingness to put time and energy into doing fundraising due diligence. The good news is that if your due diligence checks out, you can be certain that your investment in this firm will be worthwhile and that it will develop rapidly.
- Although it might be a tedious process, due diligence must be completed before an investment can be finalized and a deal sealed with investors.
How to prepare for fundraising due diligence
To attract equity investors like VCs and angel investors, you need to be ready to provide them with the data they need to do their due diligence, verify that your company meets their standards for efficiency, and investigate any risks associated with making an investment in it. Having the necessary paperwork in place ahead of time allows you to react more quickly to requests for information necessary for making informed decisions. It also demonstrates to potential backers that your money is well-organized and controlled, which then increases the rate at which money is raised.
Organizing Company Information
While individual records may appear unimportant when taken as a whole, they reveal important information about your startup’s past and present. Having a central repository for all firm records is a must for staying on top of things and preventing chaos.
As soon as due diligence begins, you will be given a comprehensive list of required paperwork, including contracts, licenses, and government forms. If you and your researchers need constant access to your due diligence files, it’s ideal to save them in a cloud storage service or a shared virtual data room (VDR).
If your company’s paperwork is in order, fundraising due diligence will move quickly and easily, saving you time and frustration. The alternative, of course, is to construct the list from the start, which may be a significant operational load and a potential distraction from other important company activity.
Financial and Operational Preparedness
Startups must provide investors with current balance sheets, income statements, and cash flow statements as part of fundraising due diligence.
If you want your financial statements to provide a clear picture of your finances and engender investor trust, you should utilize cloud accounting software instead of spreadsheets to store the books and generate the reports.
You may save time and money by outsourcing your accounting to a reliable service like Eqvista if you don’t have the resources to keep track of your accounts yourself. With the help of our accounting professionals. you can get the financial reports and predictions that will impress potential investors that you need to help you raise capital.
Legal and Regulatory Preparedness
In order to address all legal concerns, outside attorneys often conduct a legal startup audit. Legal screening encompasses business paperwork, shareholder framework, board meeting records, registration problems, compliance with GDPR, material contracts, difficulties with human resources assets, licensing, litigation, and more, even for early-stage firms.
To avoid a drawn-out and expensive legal procedure, investors naturally place a high priority on ensuring legal compliance. Make sure the auditors can quickly and readily access any and all legal records that they may need before doing fundraising due diligence.
Founders of startups should be ready to provide evidence of their legitimate ownership of all intellectual property (IP) in order to attract investors and head off any legal conflicts.
Team and Culture Preparedness
Another aspect that investors would want to be sure of is the preparation of the culture, and this is something that can be depicted using an organizational chart. In the same way that a family tree displays the ties between members of a family, an organizational chart displays the links between members of an organization. Organizational flowcharts are useful for determining whether parts of your firm are adequately funded in light of your fundraising objectives, which may involve expanding your team.
Mistakes to avoid in preparing for fundraising due diligence
Unless there is a clear path to profitability and rapid expansion, investors will not risk their money on a company. Even companies that have achieved unprecedented levels of success may nevertheless fail due to seemingly little errors. As a result, it’s crucial that you don’t mess up your fundraising due diligence preparation. The most typical blunders made by startup creators are listed here.
- Lack of Organization and Preparation – Your ability to attract investors depends on your willingness to make information readily available to them. Even if you have everything worked out and your concept is fantastic, they will want to see it written down. As we’ve discussed previously, it’s best to get a head start on documentation and keep everything in a place where it can be easily sorted.
- Inaccurate or Incomplete Financial Information – It’s crucial to be realistic if you’re already making money and can show investors how their money is doing. Potential investors can be put off by a proposal if they perceive a high burn rate or unrealistic revenue projections. Put your board of directors and trusted advisers to work for you in setting realistic financial targets. However, investors may look elsewhere to judge the worth and future potential of your firm if you are pre-revenue and have no operating income to speak of or considerably negative statistics.
- Legal and Regulatory Issues – Legal and regulatory difficulties, which may vary greatly depending on the product, are the most prevalent and time-consuming hitches in due diligence. To avoid any delays in production, think forward to acquiring the necessary patents, trademarks, and licenses for your product. Fixing issues as soon as possible is crucial because of the damage they may do to your company’s expansion plans. Having a skilled IP lawyer on hand is a good idea whether or not legal assistance is needed to resolve IP concerns.
- Lack of Team or Culture Preparedness – During the fundraising due diligence phase of a fundraising campaign, some entrepreneurs may fail to provide evidence of a strong team culture and strong work ethics. Investors care deeply about this since they need to know whether their interests and yours are aligned. It is essential for investors to meet the individuals running the company they want to back and work with. Investors will not only consider the founders’ education and professional history, but also the team’s track record, dedication, and capacity to respond to changing market circumstances and scale internationally.
- Poor Communication and Follow-up – Investors in general are busy people who are easily sidetracked. The investors will probably have forgotten much of your proposal and be gone pursuing some other shiny offer if you take a few days to connect back to them or arrange the next meeting after a pitch. Prior to pitching an angel group, schedule a time for fundraising due diligence calls. Then, follow up and remain in contact regularly. Sign everyone up for a mailing list to get updates on a regular basis, if possible. Maintain visibility and make sure they don’t forget about you or what you’re doing.
Manage your cap table for fundraising with Eqvista!
If you do your due investigation and find that the firm is credible and has substantial growth potential, you may feel confident investing in it. Although it might be a tedious process, fundraising due diligence must be completed before an investment can be finalized and a deal sealed with investors. You’ll need precise records and a firm grasp of your company’s financials to guarantee that your numbers stand up to examination and that you’re ready to address investor queries with expertise.
At Eqvista, we have a streamlined platform for cap table management which will help you navigate your due diligence with ease. Be it incorporating your firm or issuing and managing your company stocks, Eqvista is the place to start. Have queries? Contact us today!