Megumi Ikeda, GM and MD at Hearst Ventures Europe, has these 7 tips on navigating due diligence with investors
The due diligence process undertaken by investors in the run-up to fundraising is not for the fainthearted. From copies of leases to customer contracts, and shareholder minutes to employee equity schemes, entrepreneurs are required to produce a blizzard of paperwork, as well as set up a data room. Your legal advisors – and always opt for venture capital specialists, by the way – will guide you through this documentary and evidentiary maze.
However, from an investor’s perspective, some of the most important parts of the due diligence process aren’t to be found buried deep in the data or contractual sub-clauses. After all, investing in a company means working closely with its leadership team for a period of years, and neither party wants to be stuck in a dysfunctional marriage. So, here are some of the things to bear in mind, according to Hearst Ventures Europe’s Megumi Ikeda:
1.Due diligence is your last chance to pull out of the wedding
Once a term sheet has been issued, the last thing we want to do is pull out of a process. Once an investor says they’re going to invest, they should be all in. So for both sides of the table, the due diligence period is your last opportunity to make sure the numbers, market opportunity, chemistry and professional relationships all align. If they don’t, and you foresee trouble ahead, pull out. As a founder, you’re going to be spending a lot of time with your backers, and while a few pre-wedding jitters are normal, be sure – and I mean really sure – first.
2.We’ve had to walk away from some deals at the 11th hour
Sometimes, due diligence personal checks on founders have thrown up undisclosed fraud and/or legal issues, which of course derail the whole process. We’ve also had an instance where everything was lined up and we were good to go, and then the personal checks on the founder came back as ‘deeply problematic’. We’ve had to walk away from those deals, however good things looked on paper. As investors, we trust you – the entrepreneur – to approach a prospective investment in the spirit of openness, and even if it’s something relatively minor, you would always hope and expect the founder or CEO to disclose it in advance rather than for your due diligence to unearth it very late in the day.
Matillion raises $35m in Series C funding round
3. ALWAYS be upfront
If you’re upfront about where you went wrong, it won’t come across as you attempting to conceal something or sweep it under the carpet. If, say, an entrepreneur never mentions a falling out with the head of sales, resulting in delayed monetisation, or says they graduated from a particular university when they did not, it leaves investors wondering what else they might have ‘forgotten’ to mention.
4.When it comes to chemistry, every signal matters
Often the ‘softer’ side of the due diligence process – the part that’s about chemistry and relationships and that has nothing to do with financials, business plans or market opportunity – can scupper a potential deal. One time I remember the palpable tension between two members of a startup’s management team at a pitch just made us feel something was awry: if they can’t get along in public, just imagine what goes on behind the scenes? (And in fact, our instincts proved correct; we later learned that one of the founders was removed soon afterwards, and a new CEO was installed.) Every signal matters to us as investors. One colleague told me he once attended a pitch where the CEO didn’t allow the technical founder to speak at all. Now that’s a problem, especially at Seed stage, where the technical founder and what he or she can do, and how involved they are, is very important when selling the dream.
5.Your investor doesn’t need to be a friend you’ll see at the weekend
Founder/investor relations work best when there’s a good fit in terms of personality and culture. They don’t have to be a person you see on Sunday afternoon, but they do need to be someone you respect, want to seek out for advice and/or a friendly ear, and ideally someone you enjoy spending time with. Awkwardness and discomfort are likely to be magnified over time. Founders should look for someone with integrity, who treats them with respect and professionalism. They’re going to be sitting around a board table and giving up part of the cap table to their investors, so they need to feel comfortable that these are trustworthy partners for the journey ahead.
6. Always ask investors for references from founders of other companies they’ve invested in
As part of your own due diligence, ask to speak to other CEOs from their portfolio. Making your own independent approaches, by tracking down another portfolio founder through your own network or via LinkedIn, pays dividends too. The kinds of things you should be digging into are issues such as conduct on the board, availability at other times, and responsiveness to emails and requests. Practically every VC today says they offer various ancillary services – but is that actually true? And if it is, does it genuinely add value or is it just window-dressing for their website?
7. Be ready
Even if it seems a long way off on the horizon, if you know you’re going to be looking to raise money, the best thing you can do is prepare early. And the best way to do that is to make sure all necessary company documentation, data and metrics are continually updated and good to go. The last thing you want to do is to be scrambling to get everything together at the last minute, which will not only cause delays to the entire fundraising process, but won’t impress investors. Invest early in capacity to do this, which may mean adding an early hire to your finance team, otherwise you’re going to be pulling people away from their day-to-day job to gather data. You’re going to be doing that anyway, of course, but if you get the logistical work done early, you’ll impact far less on their output.