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How to Survive Investor Due Diligence

If your startup is great enough to get a term sheet from angel investors or a venture capitalist, the next step for the investor is to complete the dreaded due diligence process. This is the last step of the process, where surprises in the evaluation of the management team, documentation, and personnel problems can derail the investment.

How to Survive Investor Due Diligence

Some startups do nothing to prepare for the due diligence process, assuming the people and business plan documents will speak for themselves. Others stage elaborate “training” sessions, to “assure” that everyone tells the same story. The right answer is somewhere in between.

I believe that proactive preparation for due diligence is a bigger job than the work for investor meetings, because your whole team is involved, not just you as the CEO. If there are financial anomalies, or someone on the team doesn’t know the current strategy, or someone is unhappy with you or the company, the investment will be jeopardized.

Even if you feel that all is well, here are some thoughts and actions I would strongly recommend:

  • Whole team must know the plan. Make sure the Business Plan and all related documents are current, synchronized, and in the hands of every key employee. If everyone gives a different story, you have no story.
  • Personnel situation is stable. Ask everyone to update their resume, and personally call probable references, so there are no surprises. You need to brief the investor ahead of time if there are career anomalies or personnel situations that could be a problem.
  • Don’t surprise the team. Call a company meeting to communicate what is happening, and why. This is a good time for the CEO to present the final investor charts, and answer any questions from employees. All need to know who will be there and what you expect.
  • Contact key vendors and existing customers. Explain that they may be called, and use the opportunity to check their satisfaction with your company and your product. Again, if you find problems you can’t fix, be up-front with the investor to avoid a surprise.

Depending on the availability of staff and needed information, the due diligence process generally takes 2–6 weeks to perform. During this time or earlier, you should also be doing your own due diligence on the investor, as suggested in a recent article on avoiding problem investors.

Here is a quick summary of the priorities normally covered by the due diligence process:

  1. Evaluation of key players. This is the highest priority item. As a starting point, an investor will ask for resumes of the “key players,” and will then follow up to verify that executives are experienced, honest, and committed. That means questioning each of these key players and calling references or prior associates.
  2. Validation of product. This will cover the technology, the current state of development, and customer satisfaction. Is it something consumers need or simply want, does it work, and is it ready to ship? What are the “kinks” or certifications that need to be resolved? If the product is in customer hands, expect some customers to be interviewed.
  3. Size of the market. Having a great product or service is not enough. One of the criteria for a good investment is a large and fast-growing “potential market.” Investors will talk to their own experts on the size of the potential market and the expected growth rate. They will also assess trends in the market and how current economic, political, and demographic conditions relate.
  4. Sales and marketing strategy. This will involve an analysis of the company’s distribution channels, advertising, and pricing strategy. An investor will try to get an independent reading on competition, barriers to entry, price sensitivity, and what percentage of the market your company can expect to capture.

Remember, once investors contribute money to a company, a long-term relationship is created. Unlike a marriage, however, it may be very difficult, if not impossible, to get a divorce. Your objective is not only to survive but also to make it an enjoyable win-win relationship.

Marty is Cayenne's Chief Knowledge Officer and the Founder & CEO of Startup Professionals. His passion is nurturing the development of entrepreneurs by providing first-hand mentoring, funding assistance, and business plan development. He has over 30 years of experience in big businesses, as well as startups. View details.

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