• How-to

Actually, it’s not all that bad. Due diligence may seem like a big deal, but you need to understand that, in the end, it is akin to you checking the veggies at the grocer before you buy them.

No matter what the deal is, the paying party always likes to be cautious and patient before it doles out the money. If your pitch is successful, the VC will appoint a partner and an associate on the diligence.

This period will most likely last anywhere between two to three months. Be patient as you will probably be doing multiple meetings and be asked many a question during this phase. Keep your cool and stay confident.

Better yet, turn the tables and do your own diligence on the VC as well. You would not like a 10-calls-a-day kind of VC, would you? Talk to those who are funded by the VC. Find out how he is involved with his portfolio companies.

Here’s what the VC would be checking up on you.

How’s the business doing?
Commercial due diligence would mean that the VC will check on the business environment of the company and see whether all is healthy with it. The VC is likely to talk to industry experts, your vendors and also to customers to see if the company is, in fact, strong commercially.

Are the coffers okay?
The VC would ideally either hire an outside agency like an investment banker, or do the financial due diligence himself. He would probably do the latter for a startup. Expect to be asked a whole lot of questions about your numbers and financial forecasts.

How are the nuts and bolts looking?
A VC with expertise in technology is likely to do the technical due diligence himself, especially if it’s a tech business that is up his alley. If it isn’t, he might hire an external expert. Either way, prepare to be thoroughly grilled about your technology.

An important note: If you have passed muster on the three points mentioned above, you’ll move on to a full partner presentation and, hopefully, a term sheet. Only after that will the process move on to accounting and legal diligence. Why? Because these two are expensive deals and a VC would like to be sure of a deal before getting hit by extra costs.

Not been naughty, no?
A VC will conduct due diligence on your books and numbers of the past to see that all records are in order and nothing is missing. Hopefully you have been clean and there is no hint of IPL money on your books. You get the drift.

Strictly legal?
The VC would like to be sure that besides the agreements he signs with you, all the agreements you’ve signed with vendors and clients are clean and enforceable by law. All company legal documents must also be in order. In short, this diligence will let the VC know of the legal risks, if any, of investing in you.

This is the fifth of a multi-part series.

©Entrepreneur June 2010

Tags:
funding, VC, venture capital