Due diligence is a crucial part of many investment journeys, with each funder having have their own processes and timeframes. For this reason, and several others, due diligence can be misunderstood, particularly by founders who haven’t been through the process before.
In this latest blog, we’ve taken a deeper dive into DD from a VC’s perspective specifically, answering some of the common questions we receive from founders, starting with what is VC due diligence and why does it exist?
What is due diligence?
Before any investment completes, investors go through a due diligence process to get under the skin of a business and get an in-depth understanding of how it operates. For VCs, this process tends to take about three months.
But what does the actual due diligence process look like? Let’s say that we have just invested in a tech business. The due diligence phase would provide us with an opportunity to dive deeper into a business’s tech stack or machine learning model.
Depending on the business, we or another investor may seek to appoint a specialist in technology-related due diligence, such as Hutton Henry at Beyond MA, while we carry out our other checks, such as the go to market strategy and recruitment.
The point of this process, as well as knowing what we’re investing in, is to assess areas such as IP defensibility, the tech roadmap or a solution’s security and data privacy provisions. That’s not to say DD is only carried out on tech businesses. DD applies to every business we back, from tech for good companies to healthcare.
Don’t fear due diligence
If you’re worried about due diligence, you’re not alone. While some do shudder at the thought, the process shouldn’t be feared. Due diligence shouldn’t be seen as a cross examination of you, the founder. Nor is it about calling out faults in a business.
Businesses, particularly those at an early-stage, are very unlikely to pass every marker with flying colours, and that’s fine. The process is designed to help all parties – management and investors. After all, if you’ve got to this stage, it’s a good sign.
Really the due diligence process is about identifying where there could be areas of future risk and where investment and support is required, with the aim of building a more robust business going forward.
Unlocking value through due diligence
It’s true that, at its core, due diligence is a validation and risk mitigation exercise for investors. But, outside of this, there is also a great deal of value and reward for founders. When embraced, it can be just as valuable to founders as investors.
At Praetura Ventures, we’re known for providing ‘More Than Money’ to businesses in both the pre and post-deal stages. In this context, carrying out robust DD allows us to understand how we can best support founders and make More Than Money work.
With a deeper understanding of a business’s needs, we can appoint a relevant Operational Partner to that business, connect it with the right external expertise – e.g. R&D tax specialists through our Portfolio Toolkit – and give our Portfolio Team a better idea of what our focus should be during the months after completion.
Examples of this range from shortening the sales cycle to more complex matters, such as a tech stack that is not yet easily scalable in its current configuration. These issues can be explored during due diligence before a remediation plan is established.
How should I prepare and what is expected of me?
The best approach a founder can take with DD is to be as open, transparent and productive as possible, which is everything the DD process should be as well as collaborative and genuine. To this point, it’s important to note that DD doesn’t just involve one founder or founders. Investors often want to speak to every member of the management team as well as referencing customers. It’s a collaborative effort.
What you can do to help, as the founder, is facilitate access to your tech and product teams, documentation and systems, making the process as smooth as possible. With this in mind, it’s also incredibly important that you have a robust data room, which includes management accounts, a forecast model, cap table information, pipeline stats, analysis, market reports, current articles and the shareholder agreement etc. to support claims, such as revenue, customers, market need, size and scalability.
Remember, if you are making any claims in your investment proposition, your investor will want to validate these with clear and concrete evidence, so preparation of this will shorten the time it takes in DD. Some of this information will also be gathered via a management and legal questionnaire, which is standard practice.
If you found this blog useful, check out the other features in our series, including our advice for how to avoid failure when your business is facing hardship.
