Tl;dr: Here is a free due diligence checklist template for startups closing their round. It tells you what you probably need to have to hand before investors ask so you can close your round faster. I’ve found a lot of lawyers and advisors download it! NOTE: If you want it, it gets emailed to you automatically. Fill in the download box!
Want to save money in your fundraising process? Decrease the time to money dramatically? Give your prospective investors the impression you are a pro? Well, this is the blog for you! We’re going to deal with how to prepare yourself for a fundraise like a pro by preparing your due diligence before you start raising. At the end of the blog, there is a template due diligence template for you to download. Boom!
So you want to raise funds from VCs? Well, welcome to a world of pain. Assuming you get your pitch deck and financial model together, learned to pitch and get meetings etc, once you have interest from investors and they want to proceed the really tedious work is about to begin! Boo.
Download the due diligence checklist
What is due diligence?
The VC’s job is to give you money, but they have bosses too. They’re called limited partners. These LPs expect VCs not to do silly things, like invest in vaporware. To ensure they aren’t investing in a company with crappy tech, has a tonne of debt and liabilities, or the founders are dodgy crooks, they need to do something called ‘due diligence.’
Due diligence means checking you have dotted all your ‘i’s’ and crossed all your ‘t’s.’ For larger investments, the VCs may hire lawyers, accountants, and special advisors to check up on their respective areas. For an angel stage company, there really isn’t much to check as you haven’t had the time (hopefully) to make too much of a mess. But even then, there are things they need to know have happened, such as paying up your share capital (This happened in a fundraise I advised on) before they chuck you a couple hundred K.
The goal of DD is, therefore, to ensure the company you have created is investible from a hygiene point of view. It is also used to back up each and every statement you made in your pitch such as your revenue and number of customers.
Your goal is to not get caught with your pants down.
When does due diligence happen?
Once you have received a ‘term sheet’ and have both signed it, due diligence commences. There will be a clause in the term sheet under ‘conditions to closing’ requiring due diligence to happen before you sign the definitive documents and get cash in your bank account.
The plain English version of this clause from Passion Capital is:
Before we sign the paperwork and transfer our money, we have to do some basic due diligence on the company and also on you, the founders. This includes anti-money laundering checks and having you complete a Founder’s Questionnaire. We also want to see that all of the company’s relevant employees and freelancers have signed employment or similar contracts which make it clear that the company owns all of the intellectual property that’s been created for the business you’re building.
After signing the term sheet your investors will likely advise you the next steps that are needed to be done. They make intros to people whom you need to engage with and possible assign a point person to lead the exercise (if they are organized).
You aren’t getting any cash until due diligence is done, so make sure you are on top of all this.
How does due diligence vary?
The later stage you are and the larger the investment, the more due diligence that is going to happen. There is a fairly direct correlation here.
Let’s face it, for angel stage startups, there isn’t much to check. If you are raising $200k, why would a VC spend $50k checking things? That doesn’t make sense, right?
If you are a growth stage company, things are very different. Raising $40m is a big deal. Your VC does not want to throw caution to the wind, right? At this point you would have a CFO and some monkeys (MBA interns) to throw at pulling everything together and responding to all the requests, so the load is better for you too, although painful.
Between angel and growth, there is a sliding scale of sorts. At series-A, you are expected to be wearing big boy pants, so will need to have a far higher level of preparedness. At series-B, you will certainly be expected to be able to run a clean, effective process.
So if you are angel/seed stage, don’t stress too much. Yes, there will still be a number of docs to be provided, but you should have them mainly to hand if you are organized (e.g. staff contracts, your legal docs etc).
How long does due diligence take?
I hate this answer, but ‘it depends.’ Your min max to signing docs is 2 to 6 weeks. The more prepared you are, the faster it will be and the more control you have on the process on your end. Understand you can’t control the VC end nor the lawyers. The lawyers will be drafting the definitive docs which take time.
Time is not your friend though. As David Beisel, cofounder and Partner at NextView Ventures says:
The problem is that time kills all deals. The longer this limbo period extends, the more risk is introduced that the process will veer off course or even fall apart entirely. It should feel like things are accelerating towards a close, as opposed to marching along at a steady pace; and it certainly should not feel like deceleration towards the end.
Hire a lawyer
Like everything in raising, you need a good specialized lawyer to help you through. Yes, it is going to cost you some coins, but do you want the money or not? Yes, right? So hire a lawyer. They can help you before the raise to get your house in order and during the process.
Having said that, you can save cash by doing the heavy lifting yourself. This blog is about just that.
The best approach to due diligence (Prepare)
If you are going to get the cash you are going to have to go through due diligence. Just accept it. Once you start raising, you are going to be a very busy bee indeed. Wouldn’t it be cool if you could just focus on shmoozing for cash instead of running around with admin just before you can taste the cash? Yup.
What you want to do is assume the raise is going to happen. This means preparing for the due diligence process before you need to provide it.
Let’s go through the ways you can deal with due diligence preparation.
Boffin approach to due diligence preparation
- Start your company
- Set up a folder in the structure of my checklist and fill it as things happen
- Share that folder
Ok, I know you aren’t going to do this, but it’s worth a try. Man, you could save a lot of time if you did it though!
The smart approach to due diligence
- Decide you want to raise
- Use the due diligence checklist and prepare the data room
- Give everyone on the team tasks to provide information (e.g. HR if you have the function, instruct your lawyer) to help lessen your load
- Create a dropbox folder and input all the information you can get
- Start your raise
Assuming you aren’t a golden boy and did the boffin approach, this is the best thing you can do. When you are chatting with investors, you get to tell them “our dataroom is already prepared and we’re ready to get in the process assuming you are ready to proceed and send us a term sheet.” This makes you look like a pro and know how the game is played. Do this.
Emergency option (the normal one)
- Investors give you a term sheet
- Freak out and realise you need to provide a tonne of DD
- Work like nuts…
Once you have a term sheet you are near the promised land! But you need to do DD now! The time it takes you to provide all the DD is basically going to dictate how long it takes to get the deal done, so you can start executing. Nuts.
Do you need a pitch deck template? Here is a formatted one to ensure your deck isn’t ugly as hell and puts off investors.
How to approach due diligence checklist preparation
Let’s get pragmatic. These are the steps to set up your dataroom.
- Open my due diligence checklist. Understand the structure
- Put the due diligence checklist in the root folder. As you update it, the updates need to be reflected in it
- Set up a new Dropbox folder. Name it ‘[STARTUP] due diligence’
- Create folders in the root folder. Name them ‘A’ -> ‘M’ sequentially. For each first level folder, create a second level folder for all the second level points in the checklist you add data for. If you don’t have info for the data oint, you don’t need to add it. Make sure the second level folder has the same naming convention as the due diligence checklist
- When you have content to add to the data room, update the due diligence template and ensure you put the files in the right folder
- For each line in the checklist, in column C, use the dropdown for yes or no if you can provide the information.
- If you are in process of adding information, make a comment in column D that you are ‘in progress of updating’
- When you are done adding files, you can write ‘All information in dataroom’ as well as any comment you want to tell investors. I recommend saying you are done so you don’t forget and keep track of things. It’s easy to forget
You are now setup
How to use the dataroom in process
Cool, so you are all set up. Assuming you have VCs doing DD (Note: many VCs will do DD before giving you a term sheet) you want to share the dataroom with them (Note: the dataroom is all your due diligence information).
- Check you haven’t put anything ‘bad in the room’
- Check you have the template in the root and it makes sense and is up to date
- Check the naming convention of folders matches the due diligence checklist
- Ask your VC for a list of names and emails of people who need access to the dataroom. This is typically going to be about 3 principals (partner, principal and analyst) and maybe a few advisory people such as lawyers and accountants
- Ask your VC if advisory people have an NDA with their firm before giving them access. That agreement typically applies to all deals they work on like a ‘blanket’
- Provide access to the folder by sharing the link. Do this for the root folder
- Send your point person and CC everyone else you provided access, that they now have access. Be a pro and communicative
- If you get a request for more information, add it to the dataroom. Again, email the point person to say the information has been provided and point them to the right folder so they don’t waste time
- When VCs bow out, make sure to remove their access
- At the end of the process remove access
10 top tips for effective due diligence process
I’ve been through due diligence as a founder, advisor and a VC. I know what all sides want and think. Let me share with you tips to avoid pain and pissing people off.
- Do the dataroom before you start process: I’ve said this before. It takes time to pull all the information together unless you took the ‘boffin approach.’ Using the template you can figure out the totality of what you might need to provide. Start before the raise so you have time to pull things together. It will suck to try close a round and you have to wait on people to provide information (at the same time as you are trying to show momentum)
- If you don’t have it you don’t have it: The template is pretty much everything you will be asked. I have not included some points, but it is good to go for a growth stage deal. At seed you will not have it all. That’s ok.
- If you don’t have it and need to make it ask first: Just because there is a huge list, does not mean you ‘have’ to add it. You need to add everything ‘material.’ If you do not add ‘material’ information you can get in trouble. There will be ‘representations and warranties’ in the shareholder docs and they will say you disclosed everything. If VCs ask for all sorts not on the list, or adding something on the list will take a lot of time, call up your VC point person and ASK THEM if they really need the data point. They may not. DD sucks, so communicate a lot and make sure your time is spent right. The VCs are really looking for ‘gotchas’ so they don’t look dumb. They don’t really want to read all your boring docs.
- Over communicate: DD sucks. Communicating a lot will help you. You just need to get through it. It’s totally cool to ask ‘do you really need this?’
- Don’t use virtual data room providers: There are pretty virtual due diligence rooms available to pay for. There are all sorts of functionality. I can honestly tell you that VCs HATE these! There are browser compatibility issues, it can be hard to read docs, it’s hard to get through docs etc. Don’t use these systems. You want VCs to get done with DD asap, right? They don’t give a shit about your docs. They have no interest in stealing things. Don’t be a control freak. Make their lives easier.
- Use dropbox: It’s simple to add people. VCs know how to use it. It’s simple. Simple is good. Just do it.
- Put the index in the root folder: VCs want to know what is in the dataroom. They do not want to click through folders to find things. Having an index (my template) makes life way easier to find things.
- Use one folder system for everyone: You don’t want to have 7 folders you need to put new docs in 7 times. That’s a bad use of time. But, ‘Blue Shirt asked for x and Khaki Capital didn’t, so won’t they all see x?’ Just email a particular VC the new info if you don’t want to provide it to everyone for some reason (you don’t have to put it in the dataroom, ok?). But, competitive pressure is good. It’s not a bad thing to remind investors there are other people in process asking for information. You can tell VCs ‘another VC asked for this analysis, you can see it too.’
- Don’t stress out about ‘levels’ of a dataroom: If you have really secret stuff, only share that if and when you really need to. Assume the dataroom is for really boring stuff. You may have VCs do DD before giving you a term sheet, so don’t put in any thing you haven’t patented etc in here. The fancy virtual data rooms allow 3+ levels of dataroom depending on the stage VCs are at. This is a ball ache and annoys VCs. Just give them (almost) everything. Again, no one really gives a toss about your docs
- Don’t listen to people who say VCs don’t sign NDAs ever: VCs can and will sign NDA. If you are a later stage company and the VC wants a customer pipeline list, that is sensitive information. I personally know VCs will sign an NDA to see this stuff and will even propose to do so. They will not sign an NDA to see your articles of association though! You will ONLY get an NDA if they are interested and are in heavy dd and want specific information
Template due diligence checklist template
To download the due diligence checklist template, click below and you will magically get access to it.
Here is a quick view of the top section so you know what we are talking about.
Download the due diligence checklist template excel now!
That was an overview of how to manage your due diligence process with a due diligence checklist. If you have any questions, sound off in the comments below. Let me know what you think of the due diligence checklist template.
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