The Fundraising Due Diligence Process: A Step-by-Step Guide

In this article, you’ll find all you need to know to prepare for a smooth and efficient due diligence procedure.

How can a company learn about and deal with due diligence to complete a fundraising round? Founders must dedicate significant time and effort to attract investors and secure financing. The transaction is virtually finalized after presenting your pitch, gaining investor interest, and agreeing to terms. The final fundraising due diligence procedure stands in the way of the investor’s funds. In this article, you’ll find all you need to know to prepare for a smooth and efficient due diligence procedure, including a checklist, the importance of conducting fundraising due diligence, and a step-by-step guide to fundraising due diligence.

Fundraising Due Diligence

The fundraising due diligence procedure reveals a wealth of data on the target firm in every aspect of its business. The investors and their teams must assemble all this data to complete the due diligence study. The due diligence team will review new information and reassess the transaction.

Ensure this process is quick and smooth and you take advantage of the deal. Let’s understand the basics to understand fundraising due diligence, its importance, and what you’ll need to have ready to present to your investors.

What is Fundraising Due Diligence?

When you pitch investors to fund your business, your presentation gives a comprehensive overview of your company and its possibilities. You have identified some threats but need to analyze your business thoroughly. Investors will do their fundraising due diligence research to ensure your business is worth the investment after a successful fundraising campaign.

For example, Fundraising due diligence involves looking at the business’s good and bad and deciding if it is worth investing in. Investors will only fork over their cash if they have proof and financial documents proving your promises.

Types of Fundraising Due Diligence

Four different types of due diligence are involved in fundraising. These four types are listed below:

  • Financial Due Diligence – Paying close attention to the business’s financial results until now and checking that the figures in the financial statements can be relied upon.
  • Legal Due Diligence – Licensing, regulations, contracts, and potential legal responsibilities are frequently examined. The company’s shareholder connections and other legal matters are carefully considered.
  • Operational Due Diligence – A close look at how the business processes input into its final products. This kind of research is often regarded as the most prospective.
  • Tax Due Diligence – The tax due diligence process includes considering the impact of investing in a company given the tax obligations, noting any taxes owed, and determining if the company’s tax problems are top priorities.
  • Commercial Due Diligence – Commercial due diligence is a process where a buyer assesses a company’s position in its market and predicts potential changes. It helps buyers make informed investment decisions.

Importance of Conducting Fundraising Due Diligence

Fundraising due diligence is important because it protects the investors providing funding to the business. It allows them to analyze the startup’s business and market potential. This aims to give potential backers confidence in the firm and its leaders. Investors go through several aspects of the business, including financial statements, projections, legal papers, and other risk factors, to mitigate their possible losses.

  • Risk Reduction – Investors’ fundraising due diligence is a key step in reducing risk because it helps them determine what hazards might involve investing in a startup.
  • Informed Decision-Making – It gives investors the information they need to make smart investment decisions, ensuring their money goes to projects with a good chance of success.
  • Credibility – Doing due diligence improves a startup’s reputation and credibility in potential investors’ eyes, making them a more attractive investment target.
  • Transparency – The process makes the investment ecosystem more open, which helps investors and startups trust each other.
  • Assessment of Viability – Due diligence lets investors look at a startup’s financial health, how well it runs, and how well it follows the law. This makes sure that investors only put money into businesses that are likely to succeed.
  • Secure Investment Environment – Both investors and startups can help make an investment environment that is safe and trustworthy by doing their due diligence

Fundraising Due Diligence Checklist

With every fundraising endeavor, doing your research is a must. Only hold off once you’ve got a deal in hand. Avoid unnecessary stress and start compiling necessary materials well before approaching potential investors with your presentation.

The decision-making processes of each investor are distinctive. While these goals seem quite distinct at first glance, they need similar documentation from your company. Every startup should have seven important fundraising documents on its checklist.

  • Company Valuation Statement – Startups must determine their value using methods like SDE, EBITDA, ARR, and MRR, depending on their stage and revenue.
  • Financial Statements – Maintain up-to-date balance sheets, income, and cash flow statements using accounting software for investor confidence.
  • Financial Projections – Create realistic short-term and long-term revenue and expense forecasts based on historical data and market factors.
  • Cap Table – Keep an organized record of all investment transactions, ownership percentages, and securities dilution, especially as your startup grows.
  • Organizational Chart – Visualize your company’s structure, roles, and relationships, offering insight into team dynamics and resource allocation.
  • Intellectual Property Documents – Showcase the value of your IP portfolio, assure no infringements, and resolve any IP-related legal issues.
  • Material Agreements – Provide documentation for agreements impacting revenue, including leases, insurance policies, contracts, and employment terms.

Ensure all gathered documentation is stored securely in a data room for easy access when investors request it during fundraising.

Step-by-Step Guide to Fundraising Due Diligence

Several steps are involved when an investor conducts a fundraising due diligence process for your business. Knowing these steps is the first step to preparing for it. Let us look through it in this step-by-step guide to fundraising due diligence.

Initial Research and Information Gathering

No matter who the investor is and their fundraising due diligence process, research and analysis are an important part of the process. They will be keenly interested in your business plan and model and whether it’s sustainable in the market. They look at your business strategy to pinpoint its mission, objectives, and values and determine if you and your business can achieve it.

Usually, information on private firms is optional to be made public to the same extent as public firms. Public companies must adhere to strict accounting standards such as GAAP and IFRS. They audit more often to ensure compliance. For this reason, investors might look into any available public information, such as:

  • Watch lists
  • Sanction lists
  • List of politically exposed persons (PEP)
  • Press reports
  • May also check non-standard methods of accounting

As a first step, they may manage risk by taking a holistic view of the target firm and making educated predictions about potential dangers. The risk and compliance review includes current and future business partners, any subcontractors they may employ, or anyone with the authority to take action.

Document Review

At this stage, your investors will thoroughly review your company’s financial records, legal documents, organizational policies and procedures, and governance documents. Verifying the company’s financials is one way to ensure the CIM’s depiction of papers is accurate. These documents can include (but are not limited to) the following:

  • Balance sheets
  • Income statements
  • Equity records and holder agreements
  • Intellectual property agreements
  • Tax forms and documents
  • Trends for revenue, profit, and growth
  • History of stock and options
  • Debts, short and long-term
  • Future projections or expectations
  • Comparisons with the competition with valuation multiples and industry benchmarks

Potential investors should review corporate records to ensure everything is on board with the law and the environment. They want to avoid investing to find out later about legal problems. Tax adequacy, the resolution of pending litigation, and general respect for local laws are all considered.

Newer, smaller companies may still need to establish HR procedures. Here, investors may want to look into things like questionable layoffs, harassment claims, recruiting procedures, and the existence of workplace policies and regulations.

On-Site Visits and Interviews

Once the investors gather all the information they want, they will conduct on-site visits and interviews to understand the business operations and environment of the company. It is common practice for fundraising due diligence to include site visits.

Some grantmaking organizations or investors visit potential recipients’ locations before awarding grants. In contrast, others may do so after that as part of maintaining relationships and keeping tabs. Whereas some grantmaking organizations and investors only visit projects after awarding substantial funding.

Site visits are serious business, regardless of their frequency or purpose. This will be a more conversational inspection as they meet and survey your staff, board members, and other stakeholders.

They may be contemplating investing in a business that family or close friends founded. That is, they could be too cautious at times. To ascertain whether there is any animosity connected to the deal, they would like to interact and get to know all the involved parties. The value from the research by investors looking into a company will likely suffer due to weak leadership and internal conflicts.

Reference Checks

Investors will look at your company and evaluate your staff, customers, and the company’s connections. They may inquire about your services, products, and employees by requesting personal and client references.

While making calls or scheduling meetings, they might double-check with these references. They may contact important employees and board members with your recommendations. It is reasonable to assume that references given by a company will be biased towards the business. For this reason, Investors may also use their networks to conduct “blind” reference checks with persons who know the Founder or even other executives.

Analyzing and Reporting

Collaborative sharing and evaluation of results follow the collection and analysis of data and documents. Analysts use the data obtained for valuation procedures, which support their negotiation of the final price in dollars.

All findings, including potential bottlenecks and dangers, will be communicated to your business’s board and management team during fundraising due diligence. They can also make recommendations to overcome these issues and improve the business. Groups should act swiftly to quicken the fundraising due diligence process.

Manage your Cap Table with Eqvista!

It takes a lot of work to do due diligence, especially when you’re looking into the specifics of an industry. Investors often talk to experts in the field to get a better understanding. When doing corporate due diligence, various factors are important to think about. Due diligence can sometimes cause a deal to fail, usually when an investor finds information that the company either forgot to include or didn’t mean to. Getting Eqvista to do a full evaluation can help solve this problem. We can make this process easier for you with the help of our experienced valuation team. Get in touch with us right away to get a free valuation consultation!

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