When your company is at a point where you need a substantial infusion of cash to fund your next milestones, a venture capital (VC) investment might be the right solution. Before you approach a VC firm though, you need to be ready to withstand their due diligence.
Exactly what is VC due diligence, and how do you prepare for it?
You’re about to find out!
Why VC Investors Conduct Due Diligence
Global VC investments nearly doubled from 2020 to 2021, with over 13,000 deals completed at a combined value of just under $330 billion. While the size of a VC investment tends to vary based on the company’s stage of maturity, this figure is also increasing—with the median early-stage round reaching $10 million in 2021.
With many opportunities to consider and a lot of money at stake, VC firms need to ensure they’re betting on the right horse…and be able to defend that bet to their investors, who provide the capital these firms deploy. That means before a VC firm is willing to invest in your company, they need to understand your business from every angle. They need to be sure you have a solid offering, good product-market fit, strong growth potential, and no financial or legal stumbling blocks that would keep them from moving forward. And they need to gauge both the current state of the union (including risks and liabilities) and the future potential.
The due diligence process enables VC investors to find out all of that, and more.
A VC firm will conduct comprehensive due diligence to ensure your business meets all their criteria for a sound investment. If you’re looking to raise money through a VC investment, you’ll need to be prepared to stand up to their scrutiny and satisfy their requirements.
When VC Due Diligence Occurs
A VC firm will certainly conduct some degree of research about your company to screen the opportunity before they get into serious discussions with you. But at the early stage, most of the information will come from public sources or from your pitch deck and discussions.
Once they’ve done their initial vetting and have decided your business may be a worthwhile investment, it’s time to do a much deeper dive into your company by conducting thorough due diligence. The results of this investigation will help the VC firm decide whether to move ahead and how to structure the deal.
The due diligence process can take anywhere from one to two months, on average. One factor that will influence the timeframe is your responsiveness to the VC firm’s requests for information. They’re going to ask for a lot of documents and details…so the more prepared you are for this rigorous and time-consuming process, the more smoothly it will go.
What You’ll Need to Provide During Due Diligence
Since due diligence is an opportunity for the VC firm to “look behind the curtain” and get an objective, unfettered view of your business, much of the information they review needs to come directly from your company. To facilitate and organize the process of gathering and providing everything they need, venture capital firms typically provide a Due Diligence Checklist.
Each VC firm will have its own version of a Due Diligence Checklist, and some are more detailed than others. But generally, the checklist tends to include documents and information in the following categories.
Getting Ready: Your High-Level Venture Capital Due Diligence Checklist
Note: The following is a high-level summary of the types of documents and information a VC firm might request during due diligence. A finance specialist like Simple Startup can help you obtain a comprehensive requirements list and respond accurately and in a timely way.
- Financial: Current financial statements—including your net income (P&L) statement, balance sheet, and cash flow statement—as well as budgets, revenue and expense projections, loan agreements, a financial runway projection, and your capitalization table.
- Tax: Past tax returns and documents from audits, if any.
- Legal: Articles of incorporation, partnership agreements, customer contracts, vendor contracts, leases, and past or current lawsuits or claims.
- Intellectual property (IP): Licenses, patents, copyrights, trademarks, and other IP assets.
- Market: Addressable market size, rate of market growth, target market segments, and competitive landscape information.
- Product: Degree of product differentiation and product maturity.
- Customers: Customer list, acquisition rate and cost, and retention rate.
- Technical: Technical capabilities, processes, and scalability.
- Management Team: Credentials, resumes, previous track record, and background checks.
- Employees: Organizational chart, list of key employees, any employment agreements or contracts, and employee benefit plans.
How a Fractional CFO Can Help with Due Diligence
While there are no guarantees that a potential venture capital deal will make it over the finish line, proper preparation for the rigors of VC due diligence can increase the odds that you’ll achieve a successful outcome. Yet, it can be difficult for a founder to devote the significant time and energy this process requires, especially when you’re knee-deep in running the business.
That’s why many early-stage companies that plan to approach VC investors turn to a Fractional CFO for expert help and guidance.
Fractional CFO services allow you to obtain a slice of a highly experienced finance professional at a fraction of the cost of an in-house CFO. Since most early-stage companies can’t afford to tie up capital on an in-house senior-level finance officer, a Fractional CFO is often the most effective way to get the strategic direction and finance expertise you need to grow and thrive.
A Fractional CFO can prove invaluable in helping you prepare for venture capital due diligence. Drawing on their previous experience with investors and early-stage companies, they can:
- Help you gather and organize all the documents and information the VC firm’s due diligence checklist requires
- Prepare the financial statements that are always a critical part of VC due diligence
- Answer the VC firm’s questions about your financials and other documents
- Conduct financial modeling to help you develop accurate projections based on various scenarios
Why Simple Startup is Your Due Diligence Partner
Simple Startup has extensive experience working with investors, so we know what they look for and expect during due diligence. Our fractional finance services have helped many early-stage and later-stage companies attract the funding they need to achieve their next milestones and take their businesses to the next level.
Contact Simple Startup to schedule a meeting with an advisor, discuss your fundraising plans and goals, and learn how our fractional finance services can help you throughout the fundraising and due diligence process.