Companies intending to market some or all of their equity in order to raise growth capital should be prepared for the significant amount of Due Diligence that an Angel, Venture Capital or Private Equity investor and their advisors may require before consummating an equity financing deal.
A broad definition of Due Diligence is an investigation into the financial, legal, commercial, marketing and operational activities of a business in connection with a proposed investment – or acquisition – of the business, so that the investing or acquiring party enters into the deal with full knowledge of the facts.
A Due Diligence exercise is carried out to validate strategic ideas and to provide an independent review and support for assumptions underlying the investment opportunity. It identifies negotiation points and can help determine practical solutions for the tactical implementation of a strategy. It may also form the basis of the Terms Sheet. As such, the ‘DD process’ will usually run parallel with Terms Sheet negotiations.
The investor and its lawyers and accountants will usually undertake a Due Diligence checklist – as illustrated below. The savvy entrepreneur can literally shave weeks off the Due Diligence process by preparing the answers and documents in advance that are likely to be asked or sought after – I call this Reverse Due Diligence:
- Corporate: A review of the company’s corporate structure including any subsidiaries, business names, constituent documents, shares issued and debt securities convertible into shares.
- Assets: A review of assets owned by the company including real property, intellectual property, contractual rights and intangibles, a list of who owns the assets and any mortgages or charges over them.
- Intellectual Property: Verified ownership of any intellectual property.
- Financial Statements: The financial statements and accounts of the company will be reviewed extensively to assess the past performance and prospects of the business.
- Material Contracts: A review of the company’s key contractual relationships with suppliers and customers, key employees, strategic alliances, licensing agreements, etc.
- Employees: The company’s standard employment agreements, relationships with key employees, employee option plans, staff turnover levels and the history of disputes.
- Litigation: Any actual or threatened litigation or dispute in which the company has been or is currently involved.