Investment Process - Due Diligence

Entrepreneurs who are lucky enough to successfully navigate the screening process, covered in Investment Process-Screening, enter the next stage of the investment process called Due Diligence. 

Of all the investment stages, due diligence takes the longest amount of time to complete. The process is intending to examine a company with great detail and care in order to mitigate as much potential risk on the part of the investing party. 

Investors make a capital investment into a company in exchange for equity stake. Due diligence helps the investor understand the risk he/she is taking, which involves two components; how the capital will be utilized to grow or support the company, and how valuable the equity of the company is today and is likely to increase in the future. 

Entrepreneurs who effectively demonstrate how the capital they seek will be utilized to advance their company, why their company is worthy of investment, and how valuable the equity they are offering is likely to become, are likely to succeed in their quest to secure an investment. 

Here, we examine the steps involved in the Due Diligence process. 


The Process


Typically, the Due Diligence process starts with a 2 hour ‘deep dive’ in person meeting during which time investors ask a series of questions to entrepreneurs to evaluate the following key components of their business. 


A. The Business Model

Investors will examine the viability and growth potential of the business’s current business model, and explore whether or not the entrepreneur is willing to grow the model in different areas and/or potentially adopt different and more lucrative business models. 


B. Potential Deal Breakers

Investors will illuminate wether or not potential deal breakers current exist to making a deal, and what could constitute a deal breaker in the future. 


C. Topics or Concerns That Need Addressing

Investors will express a variety of important topics that relate to how they conduct business and negotiate deals, as well as any concerns they may have about the business, it’s strategic trajectory, and of the leadership team currently in charge.  


D. Level Of Interest

Should everything go smoothly and a strong indication of agreement is felt, investors will then share how interested they are in making a deal. They will likely express how they intend to work with you and what business philosophies guide their professional actions and investment perspective. 


E. Due Diligence Team Perspective

Lastly, the investors will express the specific steps they take during the due diligence process, what information they will expect to receive from you and how long the overall process will take. 



Entrepreneurs should expect that the the due diligence process take anywhere between 2 weeks to 2 months. 

This is no doubt a difficult time, and the anxiety can become overwhelming. However, entrepreneurs should work to remain calm and demonstrate confidence not only in their company, but that the overall due diligence process will lead to a positive outcome. 

The Due Diligence process is a lot like a test. Investors are trying to get to know the entrepreneur, how they work, what their goals are, how they see the future, and what their limits are. 

Business leaders should expect to be tested in a variety of ways, and your reaction will be impactful to whether or not a deal is eventually struck and terms signed. 


What is Examined


To better understand what investors will be looking at, and to help induce a greater sense of clam, entrepreneurs should expect the following topics to center an investors due diligence of their company. 

Each topic has corresponding questions, investors will likely a….


1. The Business Plan

What is it ? Is it feasible ? Does it generate income ? And, will it likely grow the company to at least 10X what it is now? 


2. The Financial Model

Is the model well prepared ? Is it reasonable ? And, does it demonstrate good financial acumen? What additional information is needed to improve the model ? What information would prove the validity of the financial projections ?


3. Marketing Plan

What is the plan? Is it comprehensive? Are the assumptions sound ? Who is the business targeting? Is the customer segment specific or generic? And, how large is the potential market? 


4. Customers

Does the company have any paying customers? Does the company have a reasonable customer acquisition plan ? Does the company provide real value to customers, and will they be willing to pay for it ? What is the sales cycle ?


5. Competition

Who are the competitors ? Where does the company stand compared to the competitors? What are the company’s competitive advantages ? Is the company providing a truly differentiable solution ?


6. Management Team

Who are the people leading the business ? What is their background ? Why are they the right people to lead this company ? What are the strengths and weaknesses of the entrepreneurs ? Are the company leaders coachable ?


7. Sector Experience

Do the leaders or involved parties have experience within this sector ? Where and how was that experience leveraged in this business opportunity ?


8. Historical Financials

How has the business performed over the last 6, 12, 18, etc.. months? How has the business spent its money? How much has already been invested into the company? And, do the financial documents tell a good story that matches what the entrepreneurs shared? 


9. Capitalization Table

Who is involved in the company? Who has invested in the company? And, what does the ownership structure look like?


Additional aspects investors will typically vet depending on your type of business include: 


A.    Client List & Sales Pipeline    

B.    Material Contracts

C.    Management Reference Checks

D.    Customer Reference Checks (if applicable)

E.    Intellectual Property *

F.    Representations & Warranties.


* Having any form of intellectual property can dramatically affect the attractiveness of your business to Investors. Always disclose the intellectual property you have, the form of it, and what it corresponds to. 


Each of these components will impact the ultimate decision investors make about investing in your business. 

Investors will typically delegate individuals from their due diligence team to examine the information you provide and their goal is to analyze how well your analysis matches to the contemporary business environment.

Their analysis is collected in a document called the Deal Memo, which will be further examined and explained in a future article. 

To ensure that the investor’s decision is positive, entrepreneurs should work to be as well prepared for the due diligence process and provide as much information as possible that is appropriate and representative of your company. 

Entrepreneurs should take significant time to ensure that all of their documentation aligns, and relates a similar story to the one first expressed during the screening event. 

Demonstrating a high level of thoroughness and transparency through the documents you provide to investors will not only reflect positively on your business, but also on you the entrepreneur. 

In some cases, even if the investor(s) does not see the viability of your current business, they will encourage you to try other projects because of the confidence they have in your leadership and business ability.  

They may even want to include you in their personal network to impact other projects and lend your expertise to their entrepreneurs leading other invested companies. 


Risk Management


As previously expressed, the important element for entrepreneurs to keep in mind is that the entire due diligence process is an evaluation of your proposal’s risk. 

When investors examine a company for potential investment, they are making a calculation of 3 types of risk; business risk, people risk and legal risk. 

The following chart illustrates the risk analysis investors and private equity firms use to analyze the validity and risk aversion of a potential investment deal.




Business Risk

Involves your company’s solution, the economic model, and its scalability across present and future markets. 


People Risk

Involves the people who are involved in leading the enterprise and whether or not they are the right people to lead the company into the future. 


Legal Risk

Involves the intellectual property owned by the company, and whether or not it is valuable, meaning it represents a significant barrier to possible competitor, or if it is easily protectable in the market that you operate in. 


The interplay of the three elements of risk dictate whether or not investors will be attracted to your business opportunity and be willing to negotiate a deal. Even if two areas are strong, or risk free, weakness in one area can derail any potential deal. 

Entrepreneurs should realize that minimizing the risk of each element will improve their chances to securing investment, and the easiest way to minimize risk is sound judgment and sales.

Ultimately, the economic performance of your business in the marketplace, no matter the metric, is the best way to combat any sort of risk your company may possess. 

Among the 3 areas of risk, be aware that People Risk is the easiest to manage from both the entrepreneur’s and investor’s perspective. 

It is sometimes the case that an entrepreneur is deemed unqualified to continue leading a business well after a deal is struck, and effectively removed from their leadership position. 

Therefore, entrepreneurs should carefully read and understand the language of any deal. And, they should keep an open mind about who is involved in their business. If an investor deems an individual surplus to requirements or damaging to the business, an entrepreneur must be prepared to remove them form the company. 

Investors care little for the emotional components of a business, why it was formed, how it was formed, who impacted its formation, and why an person’s involvement is important. Their decisions are economically driven and their attitude towards the management team of any business will reflect that. 

Some may truly care about the emotional side of business, however business leader should expect that the investor(s) will be dispassionate. Their goal is to be as objective as possible when considering an investment opportunity. 

Moreover, once an investor(s) becomes involved, entrepreneurs must be able to clearly and emphatically defend the involvement of any and all individuals as an economically essential element for the success of the business. 

Should conflicts of personal arise, it is important that entrepreneurs remain calm and objective about the composition of the business and it’s trajectory. 

Always focus on the big picture. 


Due Diligence Team


The last component entrepreneurs should be aware of to best position themselves during the due diligence process is to understand the team involved in vetting their company. 

A Due Diligence team will typically be comprised of a number of individuals with clearly defined roles, whose objective is to streamline the analytical process as effectively as possible. 

Every investor or venture capital group employs a different strategy, however the broad composition of the due diligence team is relatively the same between larger and smaller venture groups. 

Individual investors, naturally do the work themselves, or employ a small support staff to facilitate their investment deals. 

The structure of the due diligence team is as follows: 


1. Lead Investor. 

The role of the lead investor is to coordinate the communications and all documentation of a potential deal and capital investment into a company. The Lead Investor is the primary contact of the angel group to the entrepreneur and the company seeking capital. 

He/She participates and delegates the necessary analytical work-load, lists the key terms, a and keeps everyone update & informed throughout the process. 

Their responsibilities include creating information requests for the company, determining what the key decision drivers are, coordinating the deal memo preparation, leading the negotiation process, and determining whether external expertise is required to successfully complete the due diligence process. 

Broadly speaking, the Lead Investor coordinates with Deal Director on closing.


2. Deal Director

The role of the Deal Director is to oversee and consistently support any and all the investors involved in a specific investment opportunity throughout the due diligence and deal structuring process. 

The Deal Director is typically an expert in the sector of the company seeking capital investment. Their responsibilities include; recording notes during meetings, establishing guidelines with the Lead Investor, coordinating the due diligence process, implementing key decisions, supporting the drafting of the deal memo, determining the appropriate times to negotiate the term sheet, assisting the creation of the capitalization table, accommodating any syndicating deal with other angel and venture groups, and managing any delegation of due diligence research performed by outside analysts.


3. Due Diligence Team

Represents the supportive group organized and responsible with facilitating the Lead Investor and executing the directions of the Deal Director throughout the entire due diligence and deal structuring process. 



It is important that entrepreneurs make the effort to know each party involved in the due diligence process as well as possible. The greater the professional and human connection established over time, the more likely you will be able to provide the right information about your business, answer investor questions in the right way, satisfy any concerns, and successfully navigate the due diligence process. 


Due Diligence Checklist


Finally, to facilitate your navigation through the due diligence process, consider effectively addressing the following items about your business and providing the appropriate correspondinginformation to the Due Diligence team. 


1.    Management Reference Checks. (2 Superiors, 2 Peers, 2 Subordinates)

2.    Management CVs

3.    Management Compensation Structure

4.    Management Employment Contract

5.    Customer Reference Checks    (Typically 3 client calls)

6.    Client List Pipeline Report

7.    Distribution Model

8.    Business Partners (Typically 3 partner calls)

9.    Intellectual Property (All applications & IP copies)

10.    Material Contracts

11.    Board of Directors, Plus Background Information on Each.

12.    Financial Statements

13.    Financial Projections

14.    Capitalization Table / Cap Chart (Include Option Pool)

15.    Trade Payables

16.    Competition (At Least Top 5 Competitors) 

17.    Reps & Warranties


In addition, entrepreneurs should prepare themselves for any of the following likely questions investors will submit regarding your company. 


A.     Does the company have any outstanding legal actions?

B.    Have any of the company’s principals been involved in any bankruptcy?

C.    Are there any hostile shareholder relationships?

D.    Does the company have professional liability insurance?

E.    Have any employees been involuntarily terminated?

F.    Have any employees left the company on a basis any other than amicably?


Investors will also likely conduct individual interviews with a company’s management team and specific high-level employees to determine the following:


A.   Is the workplace a pleasant or hostile environment?

B    What is the nature of the employee contracts?

C.   Which members excluding the executive leaders are critical for the company to succeed?

D.   What is the stock-option plan and how has it been received?


Together these questions should account for the bulk of questions any potential investors will ask about a company during due diligence. 




Above everything else, it is important that entrepreneurs remain confident and optimistic about the future of the company and of securing an investment. 

Always behave as though investment in your company is inevitable, even if the present investor or group begins to demonstrate their doubt and unwillingness to arrive at a deal, remain confident. 

Maintain the absolute belief that your business opportunity will yield the support it needs to grow to the next stage, and that the next investor will understand the vision and be lucky to get involved at the current stage. 

Lastly, no matter the outcome, behave amicably and with grace. 

If an investor or group passes on your company after even several months of due diligence, remain professional and stay in contact with them about any future updates about your company. 

The investment community is relatively small, and all the big players know each other. Sometimes an investor(s) who pass on a specific deal will recommend a business and investment opportunity to another investor or group who may be more inclined to invest in the company. 

Always think about the next stage, and how you need to position yourself and your company to best leverage your strengths to get the support your business needs. 

Treat the Due Diligence process as a glass is half full exercise.

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