Funding Due Diligence

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Doing the due diligence

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How VCs will vet you

You sent a pitch deck to a potential investor, and the presentation went amazingly well. It's now just a case of sitting back and waiting for that term sheet to land in your inbox, right?

Oh, my sweet summer child, if only it was that easy.

Even if a VC loves you and your business, there's still a lot of due diligence that needs to be done. After all, when there are millions of dollars’ worth of investment on the table, they need to know you're not going to be a liability.

The good news? It pays to prepare.

Here's what you need to know about due diligence and answering all your investor's questions.

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Investors hate due diligence as much as you

Given a choice between a root canal without anaesthetic and late-stage due diligence, most founders I know will go to the dentist each and every time.

DD is something that nobody likes doing, but it has to be done.

I've had to do it as a investor, corporate aquirer, and it's not fun, it's not sexy, it's not exciting. At least root canals are over quickly.

Due diligence typically falls into two categories. Firstly, the questions asked after you've pitched. Secondly, the cross-checking that needs to be done before the term sheet falls into your hands.

Let's start with the interrogation side of the due-diligence process.

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So… many… questions

While a VC may start questioning you in the pitch, they'll continue to ask you questions for weeks afterwards.

It may feel annoying but take this questioning as a good thing. If an investor didn't want to work with you, they'd not waste their time doing it.

Questions typically come in four different flavours, which I'll go into detail about now. When you know what investors will ask, you can prep your responses in advance.

I always tell the scaleups I work with to spend as much time on their FAQs as they do on their pitch. That way, you’re never stuck for an answer, and your investors will be very impressed.

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Strategy questions

Investors want to know what your business does, why they should invest and how you can guarantee them a large exit. 

They'll ask about your company, product, and the market you're in. For example:

• What is this business all about? (Time to whip out the old elevator pitch)

• What fundamental challenges are you addressing?

• Who are your competitors, and why are you better?

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Execution questions

These are the questions that when answered correctly, show who your customers are, what your market is and any potential risks. For example:

• Who is going to buy your product, and why will they?

• How will you ensure profitable pricing?

• How do you let people know about the business?

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People questions

Even if your startup looks good on paper, an investor will not give you the time of day if there's a clash of personalities*. 

These questions will provide them with an insight into you, your team, and your values. For example:

• Who is the executive team?

• How is the organisation run?

• How well do the founders fit the problem/business?

(*Of course, if you're on track to become a unicorn, an investor might  just grin and bear it if you're awful.)

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Cash questions

A VC wants to make sure you're going to spend their cash wisely and not squander it on a team retreat to Vegas (although that does sound like fun).

For example:

• What do the numbers look like in this business?

• What will you spend the capital on?

• What could go wrong with this business?

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Want to know more about the questions a VC might ask you?

Of course you do.

I've put together a list of over 600 questions you might be asked, as well as some sample answers that will impress any investor you present to.

All these questions and answers come from decades of my own personal experience as both a founder and VC, so this guide is guaranteed to give you the edge.

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Answering those questions with a smile

When you're running on nothing but coffee and adrenaline, it can be frustrating to be asked the same question repeatedly.

However, look at it from the investor's side of things. They're not being awkward for the sake of it; they just want to give you the best chance of getting an investment.

Here's what you need to do to keep prospective VCs on side.

• Never get defensive. Investors want to work with founders that react well to stress and impossible situations, so don't get stroppy, even if you think they're kicking your tyres

• Avoid the bullshit. Investors have a sixth sense when it comes to half-baked answers and will want to know what you're trying to hide

• It's okay to say you don't have an answer. Obviously, the more you can prepare, the better, but there will be times a VC throws out a question that you've not heard. Just say you don't know the answer just, but you'll get back to them (and of course, do get back to them)

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Crossing the Ts and dotting the Is

Typically the more money you're raising, the more due diligence there is before you land that all-important term sheet.

Seed stage funding – investors aren't going to be too bothered for the sake of $50k. IPO funding – expect the whole VC company and a load of lawyers and bankers to get involved. Possibly even a priest.

In my experience, Series A and B are typically the most painful, just as the level of due diligence needed ramps up significantly.

So, what can you be expected to provide? At Series B funding, you could potentially have to offer up over 150+ documents, including but not limited to:

• The different iterations of your pitch deck

• Intellectual Property

• Team policies

• Financial data and balance sheet

• Tax records

• Registration info

• Organisational charts

• Insurance policies

• Relevant licences and permits

• Real estate documents

• Health and safety policies

Investors will be on a deadline, so they'll want all the information as quickly as possible. It's best to have an organised hard drive in the cloud that you can drop everything in, even before your fundraising campaign starts. Pre-A founders… I'm looking at you.

Assign a member of your team to make sure everything is in there, and it stays up to date. Then once the NDA is signed (more on that in a bit), you can give your investors access.

Your investors are happy, you look super-organised… everyone wins.

p.s Want to get ahead of what your prospective investors want? I also have a comprehensive VC due-diligence checklist, with over 800 battle-tested items. No word of a lie; they’ll think you’re a mind reader.

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Do you need an NDA?

When you start the due diligence process, and your investors are getting into the nitty-gritty, it's time to get an NDA sorted out.

I typically don't recommend that you do this too early in the fundraising process, as it wastes time. However, if you're sending over financials, customer details and technical data – get it signed.

If you're feeling particularly clever, you can 'tranche' your hard drive, so it's set up with varying degrees of access depending on whether an investor has signed an NDA or not.

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In summary: Expect the Spanish inquisition

It doesn't matter how detailed your pitch deck is or how amazing your presentation is; due diligence is a certainty, especially if you're at the A+ funding stage.

Being fast and comprehensive could be the difference between getting that all-important term sheet and getting a pass.

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What's next?  VC feedback

In the next playbook, I'm going to tell you about entrepreneur-investor relationships.

Why are VCs always so vague? What do they really mean when they say they haven't made a decision yet? Why are we all really here?! Let's find out.