As a startup founder, you’ve likely spent countless hours building your company from the ground up. Now, whether you’re seeking outside funding or considering a merger, you’ll need to do your startup due diligence. This process involves a thorough review of your company’s financial, legal documents, intellectual property, and more, giving potential investors or partners a clear picture of your business’s viability.

Due diligence isn’t just about paperwork, it’s about trust. For investors, it explains they’re not taking unnecessary risk but rather putting their money into a business with potential. For startups, a well-prepared due diligence package builds confidence and credibility. With around 90% of startups not surviving long-term, due diligence make the difference between securing that next round of funding or becoming another failed startup.

Below, we’ll break down what due diligence entails, why it matters for both investors and founders, and provide a comprehensive checklist to guide you through the process.

What is Startup Due Diligence?

When we talk about startup due diligence, we’re referring to a comprehensive review process that is done when a potential investor or partner takes interest and wants to dive into a business before making a commitment. This process involves assessing financial records, legal documents, intellectual property, customer contracts, and operational structures so as to provide a comprehensive view of the business.

Nobody wants to take the risk of investing their money into a startup that will fail eventually. The primary purpose of due diligence is to diminish this risk. Investors want to be convinced that they’re not walking into a minefield of hidden liabilities or unresolved issues. By understanding your business inside and out, they can identify potential pitfalls and make more informed decisions. Due diligence further allows investors to validate financial and business claims. If you say your startup is profitable or that you have a large customer base, they’ll want to verify those statements with hard data. This step builds trust and shows that you have nothing to hide.

The 4 P’s of Due Diligence

1. Product

This involves assessing your startup’s value proposition, market demand, and innovation. Investors want to know what makes your product stand out in the market and whether there is a genuine need for it. Understanding the competitive landscape and potential for growth is crucial, as it reveals the product’s long-term viability and profitability.

2. People

Evaluating the leadership team, founders, and key employees is essential because a startup’s success often depends on the people behind it. Investors will look at the backgrounds, skills, and experiences of the team to determine if they have the expertise and vision needed to drive the business forward. Strong leadership can inspire confidence in potential investors, suggesting that your startup is equipped to navigate challenges and seize opportunities.

3. Potential

This refers to understanding the market size, growth opportunities, and scalability of your business. Investors will analyze your startup’s market position and evaluate the demand for its product or service. Assessing potential also involves looking at industry trends and identifying areas for expansion. A startup with a clear growth trajectory is more likely to attract investment and support.

4. Process

Reviewing the business operations, financial records, and legal compliance is the final “P.” Investors will want to understand how your startup operates day-to-day, including its operational efficiency and the systems in place to manage risks. A solid operational process indicates that your startup is well-prepared to scale and adapt as it grows.

The Startup Due Diligence Checklist

1. Financial Documents

Investors will want to get a clear picture of your startup’s financial health, so it’s important to have a variety of financial documents ready for review. Here are some key items they’ll be looking for:

• Last three years’ profit and loss statements: These statements show how much money your business has made and spent in the last three years.
• Last three years’ balance sheets: A balance sheet provides a snapshot of your company’s financial position at a specific point in time, detailing your assets, liabilities, and equity.
• Last three years’ cash flow statements: Cash flow is the lifeblood of any business, so these statements show how cash moves in and out of your company.
• Tax returns from the previous three years: Investors often check tax returns to verify your financial claims and ensure you’re compliant with tax laws.
• Bank statements from the last six months: These give a recent look at your cash position and how you handle daily financial transactions.
• Reports on accounts payable and receivable: These reports detail what you owe to suppliers and what customers owe you, providing insights into your cash flow management.

By gathering and organizing these financial documents, you’ll be well-equipped to display your startup’s viability and potential for growth, making a strong impression on potential investors.

2. Legal Documents

Next up are your legal documents. This is where investors will want to see that everything is in order from a legal standpoint. Here are some key documents you should have ready:

• Articles of incorporation and bylaws: These documents outline your company’s structure and governance. They help investors understand how your business is set up and the rules that guide its operations.
• Shareholder agreements and operating agreements: If you have multiple owners or partners, these agreements clarify ownership stakes and the responsibilities of each party.
• Any ongoing or previous legal proceedings: It’s crucial to disclose any legal issues your startup may have faced or is currently facing. Transparency here builds trust and shows investors that you’re upfront about any potential risks.
• Non-disclosure agreements (NDAs) and employment contracts: These documents protect your intellectual property and ensure that your employees are aligned with your company’s goals.

Having these legal documents organized and accessible not only helps streamline the due diligence process but also reassures investors that your startup is compliant and well-managed.

3. Intellectual Property

Intellectual property (IP) is a significant asset for many startups, especially those in tech, SaaS or other creative industries. Investors will want to understand your IP situation, so be sure to include:

• Documentation for patents, trademarks, and copyrights: If you have any patents or trademarks, make sure you have all the paperwork ready.
• Licensing agreements: If you’ve licensed any technology or IP from other companies, include those agreements. This shows investors that you have the rights to use crucial technology that might give you a competitive edge.
• Records of any intellectual property disputes: If you’ve faced any disputes regarding your IP, it’s important to disclose those.

Being thorough with your intellectual property documentation, protects your startup and also builds credibility with investors, showing them that you have a valuable and defensible position in the market.

4. Customer Contracts

Next on your due diligence checklist are customer contracts. Investors want to see that your startup has solid relationships with its clients, as this directly impacts your revenue and growth potential. Here’s what to prepare:

• Contracts with key clients: These contracts reveal that you have secured business with significant customers.
• Pricing agreements and service level agreements (SLAs): Pricing agreements outline the terms under which you sell your products or services, while SLAs detail the level of service your customers can expect.
• Customer retention rates and projected growth metrics: Providing data on how well you retain customers and your forecasts for future growth can strengthen your case. High retention rates indicate customer satisfaction and loyalty, which are attractive qualities to potential investors.

Having this information organized not only shows your startup’s reliability but also helps build confidence among investors on your ability to consistently generate revenue.

5. Operational Information

Investors want to understand how your business operates and runs on a daily basis, so include:

• Organizational structure and team roles: An overview of your team and how responsibilities are distributed.
• Key operational processes: This may include your sales process, production workflows, and customer service protocols.
• Performance metrics and KPIs: Share your key performance indicators (KPIs) and how you measure success. This information gives investors insight into how you track progress and make data-driven decisions.

6. Market Analysis

Investors also want to know that you understand the landscape in which your startup operates. Here’s what to include:

• Market size and growth potential: Provide data on the size of your target market and its growth trends.
• Competitive analysis: Highlight your competitors and what sets your startup apart. Include details about their strengths and weaknesses, and explain how you position yourself in the market.
• Customer demographics and behavior: Share insights into who your customers are, their buying behaviors, and how you plan to reach them.

7. Future Projections and Growth Strategy

Last but not least, your due diligence checklist should include future projections and your growth strategy. Investors want to know where your startup is headed. Here’s what to prepare:

• Financial projections for the next three to five years: Provide forecasts that outline your expected revenue, expenses, and profitability. Make sure these projections are realistic and backed by data.
• Growth strategy and milestones: Clearly outline your plan for growth. What key milestones do you aim to achieve in the coming years? This may include product launches, market expansions, or significant partnerships.
• Funding requirements and use of proceeds: Be transparent about how much funding you need and how you plan to use it.

Best Practices for Startup Due Diligence

1. Preparation

Preparing for due diligence isn’t just a last-minute task; it’s something you should start early in your startup journey. This means keeping your financial and legal documents updated regularly, ensuring all contracts are in place, and staying on top of your operational processes. The better prepared you are, the more confident you’ll feel when the time comes for investors to review your materials.

2. Transparency

One of the most crucial aspects of the due diligence process is transparency. Investors appreciate when startups are open and honest about their operations, financial health, and potential risks. Don’t hide any issues but rather address them directly. This openness builds trust and shows you are committed to integrity, making investors more likely to see your startup as a worthy investment.

3. Organization

Having a well-organized repository for all your documents and data is vital for an efficient review process. Consider creating a digital data room where you can store all relevant information such as financial statements, legal documents, customer contracts, and operational details. This organization not only speeds up the due diligence process but also reflects professionalism.

4. Professional Help

Don’t hesitate to seek out professional help when preparing for due diligence. Engaging financial, legal, and operational experts can provide invaluable assistance. They can help ensure that your documents are in order, your financial statements are accurate, and that you’re compliant with all necessary regulations. Their expertise can also help you identify and address any potential risks before investors come knocking.

5. Follow-up

Finally, after the due diligence process is complete, it’s important to act on the findings. Take the time to review the feedback from investors and identify areas where you can improve. Whether it’s addressing gaps in documentation or refining your business strategy, your ability to adapt and evolve based on feedback speaks volumes about your leadership and commitment to success.

Preparing for startup due diligence is a vital step in securing investment. By staying organized, transparent, and proactive, you can build trust with investors and increase your chances of success.

Final Words

At Mac Adebowale Professional Services, we help you prepare thoroughly your comprehensive Checklist ensuring your financial, legal, and operational aspects are in top shape. From assessing your product’s value to verifying financial health, we cover it all, so you can focus on growing your business.

Contact us at emails@macadebowale.com or macadebowaleadvisory@gmail.com and let’s get started! Secure the investment and support your startup deserves.