Lesson 5: Due Diligence

The Due Diligence Process

We have already covered what a “data room” is and how it plays a role in the due diligence process that investors conduct in order to verify that they understand and like the details of your company, especially the financials, the staffing and the market traction. However, managing the due diligence process can be tricky since it is an indelible component of the investment deal process.

On the one hand, you want to give investors the detailed information that they require to feel comfortable about making an investment in your company. If it’s a VC, the due diligence process is very important for them because they have to show to their superiors at the VC fund as well as their underlying investors, be it the wealthy individuals or financial institutions that gave them the money to invest with, that they have done their “homework.” To this end, investors will look under every rock, stone, and piece of driftwood to make sure that the company is legitimate, ethical, managed well and in possession of real assets that have value.

Think of the due diligence stage as a full-fledged investigation into your company. The investor will not only perform quantitative analysis of your financials, but also evaluate your team, operations, and market position by going out to speak with former employees, competitors, and experts in your given industry. VCs do this because it reduces risk for investors, as well as helps them plan for the future. And if the deal has not been closed yet, having investors explore the data room keeps them in the deal.

However, keep in mind that due diligence can also become an excuse for investors to drag their feet by taking too much time to review your company. They can even keep asking you for more and more information. Just when you think you have provided all the important documentation, they request more documentation. Unless your company is a multi-billion dollar corporation with global operations and an outstanding employee base, the due diligence process should take no longer than 60 days.

Investors try to delay decisions for several reasons that benefit them, such as more time to stockpile more cash or to look at other companies or to try to make the company’s leaders nervous in order to negotiate more favourable terms for the investor. However, at some point you have to decide whether the investor is taking too long – well beyond anything reasonable. You cannot continue to be burdened by an investor who requires what seems to be an everlasting cycle of due diligence. At times, investors can make excessive demands.

If anything, you have to be willing to push the investor and push back against excessive demands. Reasonable demands should be upheld. This is, after all, your company, and entering an investment deal with investors is a long-term partnership. You do not want to tie yourself down to potential investors that will mistreat you and your company. Always cooperate in the due diligence phase, but don’t waste your time if the investor is stringing you along.