Fundraising Due Diligence: What it is and why it matters

We will discuss what it is and why it matters, including the importance of fundraising due diligence, how to conduct it, and the checklist.

Is Due Diligence necessary for FundRaising? Understanding the Fundraising Due Diligence that your firm will encounter from possible investors and being ready to satisfy the objective will allow you to swiftly finish your seed funding, Series A round, and subsequent rounds.

Due diligence, frequently followed by talks on the investment agreement’s final form, is essential in a successful investment process. We have prepared a comprehensive walkthrough for you in this article to help you understand the intricacies of fundraising due diligence.

We will discuss what it is and why it matters, including the importance of fundraising due diligence, how to conduct it, and the checklist.

Fundraising Due Diligence

Suppose you found an investor and sealed the deal by signing the term sheet. However, is the deal sealed? The answer is no, as the due diligence process stands between you and the fund you will get.

Beginning with the basics, we should first know what fundraising due diligence is, its importance, the steps involved in fundraising due diligence, its types, and the benefits and risks.

What is Fundraising Due Diligence?

Lawtrades, a freelance platform for the online legal community, defines fundraising due diligence as the procedure through which investors verify that a company will be a lucrative and promising investment.

Due diligence is all about the details, both positive and negative. Investors want proof of your claims, including copies of contracts attesting to client commitments, test findings proving your performance claims, market research, and financial records before they spend their money. Throughout a company’s pitch, you give an overview of the company and its potential. Thus, they will research your company’s financial and organizational condition.

Benefits of Conducting Fundraising Due Diligence

Conducting due diligence provides several benefits to investors, acquirers, and other parties involved in a transaction. Conducting fundraising due diligence helps in Identifying potential risks associated with the investment.

  • Risk Identification – Due diligence helps identify potential risks related to the investment, allowing investors to make informed decisions and take necessary precautions.
  • Enhanced Understanding – It provides a deeper understanding of the company’s financial health, operational efficiency, and overall performance.
  • Negotiation Facilitation – By highlighting the company’s strengths and weaknesses, due diligence assists in negotiation processes, enabling transparent and informed discussions among parties.
  • Legal and Regulatory Compliance – It ensures that the company adheres to relevant laws and regulations, identifying any legal or regulatory issues that need to be addressed, thus reducing legal risks.

Six Steps Involved in Fundraising Due Diligence

Fundraising due diligence is quite a prolonged and complicated process that involves several steps as below:

  • Evaluation of company goals – Setting business goals is always the initial stage in every endeavor. This makes it easier to identify the needed resources, what information you need to gather, and how to ensure alignment with the overall business strategy.
  • Analyzing business financials – Analyzing business financials involves conducting an extensive audit of financial documents to ensure the accuracy of the information presented in the Confidentiality Information Memorandum (CIM). It also assists in assessing the asset health of the business, evaluating overall financial performance and stability, and spotting any warning signs.
  • Inspecting documents – Review all documents, inspect them thoroughly, and ensure they are up-to-date, complete, and accurate. Eventually, the investor is going to ask for documents for conducting interviews and audits. This can help streamline the due diligence process and avoid delays or misunderstandings.
  • Analysis of business plan and model – In this step, the investor pays close attention to the business strategies and model of the target company. This determines its viability and how well the company’s model would work with the investors.
  • Formation of the final offering – After gathering and analyzing data and documents, individuals and groups discuss and assess their results. Analysts then use the information collected to undertake valuation procedures.
  • Risk Assessment – This step includes identifying and evaluating potential risks associated with the investment, such as regulatory, operational, or market risks.

How to Conduct Fundraising Due Diligence

Fundraising due diligence involves a systematic and thorough review of the company’s operations, financials, legal and regulatory compliance, and other key areas. If you are conducting due diligence, there are some essential tips, tools, resources, and practices to consider. We have explained below in detail how to conduct fundraising due diligence.

Tips for Conducting Fundraising Due Diligence

When conducting fundraising due diligence, there are several tips you can follow to ensure that you make an informed decision:

Tips for Conducting Fundraising Due Diligence

  • Know Your Purpose – Understanding your Organization’s purpose is crucial. You should know your company’s primary responsibilities. It would be best to comprehend your company’s basic philosophy and what it hopes to gain from fundraising due diligence.
  • Establish a Team and Process – Form a team with a verifiable track record over a full cycle to demonstrate competence in every investment aspect. Your team should include individuals with expertise in finance, legal, operations, and other relevant areas.
  • Develop a Checklist – Create a checklist outlining key areas for fundraising due diligence. To guarantee complete protection, covering all relevant areas and avoiding overlooking anything is essential.
  • Review Financial Documents – Reviewing financial documents is an essential part of conducting due diligence when considering an investment in a company. Identify the financial documents that need to be reviewed, verify their accuracy, analyze financial trends, review the auditor’s report, identify liabilities, and evaluate financial ratios.
  • Conduct Interviews – By conducting interviews with key stakeholders, you can gain valuable insights into the company’s operations, management, culture, and reputation, which can help you make well-informed investment decisions.
  • Conduct Site Visits – Site visits are a crucial component of the due diligence research procedure and help the business set higher standards for itself. Some foundations use pre-grant site visits in specific circumstances. In contrast, others use post-grant site visits for ongoing relationship building and project monitoring.
  • Analyze and Report Findings – After conducting due diligence, analyzing and reporting your findings clearly and concisely is important. Organize your results by categories, provide contexts, highlight risks, give recommendations, and be objective while reporting.

Types of Fundraising Due Diligence And Examples

Here are the four most common types of fundraising due diligence:

Financial Due Diligence

This type of due diligence involves reviewing the company’s financial statements, accounting records, tax returns, and other financial data to evaluate the company’s financial performance, revenue potential, and profitability.

Example: An investor is considering investing in a tech startup. During financial due diligence, they review the startup’s financial statements, which show consistent revenue growth over the past three years. This data indicates the company’s potential for profitability and return on investment.

Legal Due Diligence

Legal due diligence involves reviewing the company’s legal documents, such as contracts, regulatory filings, intellectual property filings, and other legal agreements, to ensure they are valid and enforceable and to identify any legal risks or liabilities.

Example: A venture capitalist is interested in investing in a biotech company. Legal due diligence reveals that the company holds valid and enforceable patents for its innovative drug formulations, ensuring protection against intellectual property disputes.

Operational Due Diligence

This type of due diligence involves reviewing the company’s operational processes, supply chain, and logistics to evaluate the company’s efficiency and effectiveness. This may include analyzing the company’s customer base, distribution channels, and manufacturing processes.

Example: An angel investor is looking into a manufacturing company. Operational due diligence involves evaluating the company’s manufacturing processes and supply chain. The analysis shows that the company has a well-optimized, cost-effective production process with efficient inventory management, making it an attractive investment.

Tax Due Diligence

Tax due diligence involves concentrating on all of the company’s tax matters and ensuring that all of its tax liabilities are completely sorted and paid on time. Tax-related due diligence also considers how a merger can influence the tax obligations of the new firm formed by the transaction.

Example: A private equity firm is considering the acquisition of an e-commerce business. Tax due diligence reveals that the business has diligently paid all its tax obligations and that the merger will not significantly impact its tax liabilities, making the acquisition financially viable.

The Consequences of Neglecting Fundraising Due Diligence

Not conducting fundraising due diligence can expose investors, acquirers, and other parties involved in a transaction to several risks.

  • A lack of financial due diligence can result in undisclosed liabilities, such as legal or regulatory issues, that may affect the company’s financial performance or reputation.
  • Undisclosed risks, such as operational or market risks, may affect a company’s future performance or growth potential without due diligence.
  • Failure to conduct due diligence can lead to negative publicity, reputational damage, and loss of trust and confidence in the investor or acquirer.

Example: In 2016, the Silicon Valley startup Theranos faced a major scandal. Despite receiving significant investments, it turned out their claims of groundbreaking blood testing technology were false. The company’s founder, Elizabeth Holmes, faced multiple fraud charges. This case highlighted the risks of not doing proper research and the importance for investors to thoroughly check a company’s background.

Skipping due diligence in Silicon Valley can lead to inflated valuations, unrealistic hopes, and, in the end, startup failures. To avoid these issues, investors should always do their homework and research before investing in a company.

Tools and Resources Available for Fundraising Due Diligence

There are several tools and resources available to facilitate the conduct of fundraising due diligence. Here are some tools to make your process efficient

  • The Due Diligence Tool – This is a guide for pre-grant assessment created by Liza Culick, Kristen Godard, and Natasha Terk La Piana Associates, Inc. It is intended for use by grantmakers and includes sections on the intended use of grant funds, lobbying, electioneering, terrorism, charitable status, grants to tax-exempt public charities, grants to other types of organizations, expenditure responsibility, and fiscal sponsors.
  • LexisNexis – This platform provides donor due diligence tools that monitor negative news, watchlists, and legal documents. They also offer best practices for risk management with donor due diligence tools.
  • Enkel Backoffice Solutions – This platform provides a fundraising due diligence checklist for startups. It includes a company valuation statement, financial projections, a cap table, and more. They also offer accounting services to help startups prepare their finances for fundraising.
  • OECD – The OECD provides a list of available tools and resources to support due diligence. These include tools and resources to measure and assess the social and environmental impact of a company’s operations, tools and resources to help companies meet SDGs through due diligence and more.
  • Charity Excellence Framework – This platform provides a charity due diligence template and checklist for donations, new fundraising donors, grants, contractors, or others to comply with donor rules and regulations. It includes links to the Charity Commission’s due diligence compliance toolkits and checklists for donations, donors, and partners.
  • Fidelity – This platform provides a fundraising due diligence checklist for startups. It includes key points for startup leaders in the financial due diligence process with investors, such as actions and minutes, charter documents and organization, equity records and equity holder agreements, and more. They also offer additional information and resources for startups in the fundraising process.
  • Xapien – This platform provides a fundraising due diligence tool that takes due diligence to the next level by being simple to use, saving on training resources, and enabling due diligence to be carried out immediately. It includes sections on the intended use of grant funds, lobbying, etc.
  • GrantStation – This platform provides a due diligence checklist for grant-seekers to help them prepare for the grant application process. The checklist includes sections on organizational information, financial information, program information, and more. It also includes tips on how to conduct research on potential funders and how to prepare for site visits.
  • The Bridgespan Group – This platform provides a due diligence toolkit for nonprofits to help them assess the risks associated with accepting funding from foundations and other donors. The toolkit includes guidance on how to conduct due diligence checks and also has templates for due diligence questionnaires and checklists.
  • Virtual Data Room (VDR) Software – This software supports storing, indexing, and sharing of confidential documents. They also offer collaboration tools and user analytics. VDR software options for due diligence include Ansarada, Datasite, Digify, DocSend, Firmex, and EthosData.

Fundraising Due Diligence Checklist

During fundraising due diligence, several aspects need your attention to make your work easier.

Actions and MinutesAll stockholder and board actions must be documented, along with recording all stockholder and board meeting minutes.
Charter Documents and OrganizationRecords about the formation and organization of your business, such as the organizational chart, bylaws, and certificate of incorporation.
Equity Records and Equity Holder AgreementsInvestors view a fully diluted cap table and related documents, such as option grants, a list of vesting schedules, and signed investor voting agreements
Legal and RegulatoryAny pending legal actions, consent decrees, or securities filings should be reported to investors.
Intellectual PropertyPatents, copyrights, and trademarks are some items included in IP agreements.
Management, Employees, and ConsultantsProviding information about employees is crucial, such as stock options, employee offer letters, benefits, and profit-sharing plans.
Debt FinancingInvestors will need to report on the company's venture debt deals and their terms to assess the company's financial position.
Other Agreements to Which the Company or any Subsidiary is a PartyThe details of your interactions with outside stakeholders should be disclosed.
MiscellaneousSuch as your company's 409A valuations, annual budgets, audited financial statements, and directors/officers' insurance policies.

Have Experts Perform a Valuation for Your Fundraising!

The process of due diligence is exhaustive. When trying to grasp the intricacies of a sector, investors often seek counsel from professionals working inside it. When doing diligence on a corporation, it is important to consider the above-mentioned elements. However, due diligence might still cause a contract to fall through. It occurs most often when an investor discovers information that the corporation omitted to disclose, either purposefully or unintentionally.

Eqvista do a thorough appraisal may assist with this problem. Let our team of value experts ease the burden of this procedure for you. Our outstanding cap table integrated system will make your due diligence procedure easier. Get ready for your due diligence process with Eqvista!

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