Raising capital for your business is a thrilling milestone, but the journey doesn't end with receiving a term sheet from an investor. In fact, it’s just the beginning of a detailed and important process known as due diligence. This is the phase where the investor will dive deep into your business, verifying the information you’ve shared and making sure everything is in order. As an entrepreneur, understanding what to expect next is crucial to moving forward smoothly.
1. Your Entity Should Be Set Up Already
By the time you receive a term sheet, you should have your business entity set up correctly. This means having your company registered, with all your basic corporate documents in place. Investors won’t expect you to go back and fix things during due diligence—they want to see that you’ve already done the groundwork and your business is running compliantly. This foundational step is essential to ensure there are no red flags when the investor’s team begins their review.
2. Providing Key Documents for Review
Once the term sheet is signed, the next step is to provide the investor with everything they need for their due diligence process. They will request a series of documents that help them assess the health and structure of your company. These documents will vary depending on the stage of your company and the investor’s specific needs, but they generally include:
- Financial Statements: Profit and loss statements, balance sheets, and tax returns.
- Corporate Documents: Articles of incorporation, operating agreements, and shareholder agreements.
- Employee Agreements: Contracts or offer letters with key employees or contractors.
- Board Minutes and Resolutions: Proof of decisions made by your board of directors.
This is essentially your chance to prove that your business is in good standing and that the information you’ve shared so far is accurate and complete.
3. Corporate Governance and Internal Compliance
Investors will want to ensure that your company’s corporate governance is sound. This involves checking that you’ve set up a proper board of directors and that all your business decisions are documented correctly. Some of the specific documents they’ll request might include:
- Bylaws: These are the rules that govern how your company operates. It’s a key document that helps investors understand how decisions are made within the company.
- Cap Table: This is a crucial document that outlines who owns what portion of the company. It’s important that your cap table is accurate and up to date, as investors will use it to understand the ownership structure of your business.
- Share Purchase Agreements: If you’ve issued shares, investors will want to see the agreements that lay out how those shares were sold or allocated, along with the terms.
The goal is to ensure everything is in order, and that the company’s structure is solid, transparent, and ready for the next phase of growth.
4. Legal and Operational Due Diligence
Beyond the basic corporate structure, the investor’s legal team will dive into the specifics of your company’s legal standing. This includes:
- Intellectual Property: Are your IP assets clearly owned by the company? Do you have patents, trademarks, or copyrights that need to be reviewed?
- Litigation: Are there any ongoing or potential lawsuits that could affect your business? Investors will want to understand if any legal risks exist.
- Compliance and Regulation: Are you compliant with relevant regulations and laws, such as data protection, tax laws, or industry-specific requirements?
This part of the process can feel invasive, but it’s essential for the investor to ensure that there are no hidden risks. Be prepared to provide access to your legal documents and be transparent about any challenges your company may be facing.
5. Financial Review
The investor will spend a significant amount of time reviewing your financial statements. They’ll want to ensure that your business is financially healthy and that the projections you’ve provided align with the reality of your financial situation. This could include:
- Revenue Models: How does your business make money, and is this model sustainable long-term?
- Profit and Loss Statements: Are you currently profitable, or are you projecting profitability in the near future?
- Tax Returns and Balance Sheets: Investors will look at your financial history and your company’s balance sheet to get a clear picture of your business's financial health.
- Cash Flow Statements: This shows how money moves in and out of your business, which is crucial for understanding liquidity and operational efficiency.
Having your financials in order is essential. Investors will scrutinize your numbers to ensure there are no surprises down the road.
6. The Investor’s Legal Team and Process
Due diligence is not something you do alone. Once the term sheet is signed, it’s the investor’s legal team that will typically lead the process. They’ll provide you with a list of documents they need from you and will review everything carefully to ensure there are no issues. It’s common to feel overwhelmed by the amount of information requested, but keep in mind that the legal team is there to protect both your business and the investor’s interests.
This process can take time—anywhere from a few weeks to a couple of months, depending on the complexity of your business and the amount of documentation required. However, it’s a necessary part of securing the investment and ensuring everything is in order before you receive the funds.
Final Thoughts:
Due diligence may seem like a daunting process, but it’s an essential step toward securing funding and growing your business. By ensuring your company’s governance, legal standing, and financials are all in order, you can set yourself up for a smooth funding experience. To learn more about the due diligence process and hear from experts like Spencer from Commenda, check out our YouTube video for more insights!
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