Due Diligence

Confirming the Facts as an Entrepreneur

Due Diligence: Agenda

• Due Diligence Process• Be prepared• Critical documents• Management team• Marketing plans• Revenue• Yes/No questions• Deal Breakers• Additional topics

• Due Diligence Checklist• Due Diligence Tips

Due Diligence Process

• Primary objectives• Mitigate risk• Understand the company and its business• Determine the suitability of the investment

• Uses the same information used to build the business plan

• An opportunity to develop mutual trust• Beneficial and time-consuming

Due Diligence Process: Be Prepared

• Create organized information gathering and storing processes from Day 1 of the firm

Digitize all critical documentsDevelop a secure, organized system for filing paper copiesCreate an electronic “due diligence room”Develop a backup and disaster recovery plan

• Start due diligence process long before you talk to the first investor

• Ask local angel groups for their due diligence checklist and documents

• Seek adviceAsk local angels what they expect from due diligenceGo to a business incubator and ask for helpTalk to your attorney, accountant, or CPA

Due Diligence Process: Critical Documents

• All legal documents• Articles of incorporation• Contracts• Employment contracts• NDA• Non-competes• Stock Option Plan• SEC documents• Leases—PP&E

• Financial Documents• Historical/YTD actual and Plan• Payables• Cap Table• Current, projected to exit• Match capital requirements to critical milestones

• Technology and IP Protection• Patents—applications/granted• Licenses

Due Diligence Process: Management Team

• Management CVs• Management Compensation Structure• Personal, professional, financial references

• Bosses/peers/subordinates• Investors will collect information from names you

don’t supply

• Education/degree verification• Perform an Internet search on every manager• Review Facebook, LinkedIn, any other social

media sites• Expect background checks

Due Diligence Process: Marketing Plans

• Fully developed go-to-market strategy and marketing plan

• Business Partners Assessment• Strategy importance• Contact information

• Competition• Communications/PR/advertising plans and

commitments

Due Diligence Process: Revenue

• Growth assumptions• Customer information—Dive deep!

• #/time period• Customer list/pipeline report• Sales funnel analysis• Distribution channels

Internal/externalTrainingDegree of readinessLead generation, prioritization

Due Diligence Process: Revenue (cont.)

• How do you and your investors make money?

• Cost of acquiring a customer• Pricing strategy• Exit strategy

Due Diligence Process: Yes/No Questions

• Do you have past, pending or foreseeable legal action?

• Have any principals been involved in personal or business bankruptcy?

• Are there hostile relationships with any shareholder?

• Do you have professional liability insurance?• Have any employees been involuntarily

terminated?• Have any employees left the company on any

basis other than amicably?

Due Diligence: Deal Breakers

• Concerns of ethics or character• Receiving conflicting information from the entrepreneur• Prior bankruptcy• Prior arrests or convictions• Naïve or inexperienced entrepreneur• Negotiating style• Not coachable• Reluctant to hire missing expertise• Issues with intellectual property—patents, licenses,

ownership• Harmful pre-existing agreements with employees,

vendors, partners, or shareholders

Due Diligence: Deal Breakers (contd.)

• Entrepreneur unwilling to invest his/her own money or accept below market salary

• Using new capital to pay off current liabilities• Valuation that is beyond norms• Unacceptable terms• Insisting on a non-disclosure agreement—

investors don’t sign them• Complex shareholder agreements• A business plan that doesn’t scale• Competition that is too far out in front• Something about the deal “doesn’t feel right”

Due Diligence: Additional Topics

• Board of Directors—background and contact information

• Technology and IP assessment

Due Diligence Checklist1. Table of Contents2. Executive Summary3. Corporate Documents

1. Form of Incorporation and where registered

2. Articles3. Bylaws4. Operating Agreement (if

relevant)

4. Management: Founders, Officers, and Key Employees

1. Resumes and references with full contact information

2. Employment agreements3. Board members4. Advisory board members5. Legal counsel, accounting

firm, etc.

5. Technology/Product1. Intellectual Property

documents1. Patents or Filings and

status2. Copyrights3. Trade Marks4. Trade Secrets

5. Technology/Product-Intellectual Property Documents (cont.)

1. License Agreement2. Prototype/Product3. Basic description/drawings/schematics4. Bill of materials5. Supplier/vendor/partner agreements6. Development timeline/schedule/milestones

6. Market1. Market analysis (North America and Global)2. Segment analysis3. Channels4. Competitor analysis

7. Customer1. Existing or potential customer contacts2. Customer contracts/software licensing

agreements3. Customer comments4. Product literature

8. Financials5. Income statement, P&L by month for 24

months b.6. Quarterly for next 3 years7. Balance sheet8. Capitalization Table9. Subscription Agreements10. Principal assumptions

9. Full business plan/Offering Memorandum10. Investor Presentaiton

Due Diligence: Tips

• Anticipate and prepare for due diligence process from Day 1

• People get funded, not business plans• Follow the intent and letter of the law• Be open and honest• Increase the level of trust between entrepreneur and

investor with each interaction• Keep assumptions in line with typical industry standards• Be up front about risks and weaknesses• Don’t put off the term sheet until the end; why do all

the diligence if there’s a deal-breaker in the terms?• When an investor asks, be ready and move quickly to

respond before they lose interest