This means a thorough and complete investigation of the company by the potential investors. All pertinent facts must be examined and confirmed, including all financial records, stock holdings and anything else deemed relevant, or which materially contributes to the deal. On the founder's part, it's necessary to confirm that investors actually possess sufficient resources to meet the terms, and to ensure that all matters relevant to the company are covered, including post-contractual elements that might affect its business.
This process falls under three general headings: getting to know each other, familiarising investors with the company and agreeing key documents and legal obligations.
Getting to know each other
For a founder, choosing an investor shouldn't just be about what monies they have to offer. It should also matter what kind of person or enterprise they are, what other companies they've invested in previously, and what the results were of those investments. Good investors won't only care about the financial returns, but about the business itself, how it runs, what its goals are and how to achieve them. The same goes for investors. They also want to get to know their founder(s), to see what they’ve previously achieved, and how their their present company is structured. This should present a good indication of the founders' personalities, their entrepreneurial expertise and past experience. No-one is going to make money on a struggling, lack-lustre business, and everyone wants to get back to work, to focus their energies on building a successful enterprise, where who dares, wins.
To discover this type of information, some investors use a founder questionnaire – but it doesn't hurt to talk to each other. Getting to know the people behind the paperwork can be done far more easily face-to-face (even electronically), and far more quickly than in lengthy email exchanges.
Naturally, investors will want references and background checks, and they can employ strategies to determine whether any of those references are bogus. Talking to the founder(s) will give some initial clues as to their characters, but it's also useful to make calls to referees and get background from real people. Many investors will want a hands-on, collaborative relationship throughout the whole process, but in negotiations such as this it's inevitable that sometimes, game-faces will be in evidence. Reference calls can help to discover the people behind the public personae, and this is a very valuable resource.
Getting to know the business
This is the point where investors look at the nuts and bolts of the business. They'll be examining financial statements, previous funding rounds, key contracts for the company's service providers, and how they were structured. They will also evaluate how strategically the company's infrastructure, legal and business processes have been planned, as well as things like company values, branding and intellectual property. Then there's the DD on the technology itself, to evaluate its scalability (if relevant). These processes help demonstrate to what degree individuals and teams are organised, going behind the public pitch – and the better organised a company is, the more likely it is to achieve success. Long term strategic planning, scrupulous documentation and a close attention to detail are good indicators that a business is founded on solid principles.
Agreeing key documents and legal obligations
Several key documents need to be in place before any investments are completed and cash changes hands. The main (and most time-consuming) legal agreements are the Articles of Association, the Shareholders Agreement and Subscription Agreements. Many experienced investors will already have standard term sheets, and most try to keep the legal obligations as simple and straightforward as possible. For institutions, they are likely to need watertight employment contracts, proofed against any future eventualities. No-one likes to be surprised by unexpected or negative events, so both sides should try and cover all eventualities.
At this point, founders should be thinking about consulting accountants for advice on tax, legal and accounting matters, unless they are already experienced in such negotiations. Parties should consult the most reliable and reputable experts they can find, and ensure there is an achievable balance between quality and quantity. Naturally, lawyers and accountants want the best possible deal for their clients, but it does need to be wrapped up within a reasonable time scale so that people can get back to business. Shop around, get some referrals or ratings, and make sure that any protracted amendment negotiations are actually valid. It may be cynical to think that consultants are lining their own pockets by spinning out the negotiations longer than necessary, but it is not unheard of.
Post-termsheet torture and how to avoid it
- Keep it simple. The less complexity, the faster the process may be completed.
- Keep the ball rolling. Remember that making concessions can ultimately get a better deal if you keep negotiations moving. Don't forget that face-to-face communications encourage faster and less complicated manoeuvring.
- Use trustworthy professionals for drafting the documentation, and try to develop an ongoing relationship with trusted advisors. They can take care of peripherals while the deal team focuses on the critical business issues.
- Don't enter negotiations with eyes wide shut. DD means doing exhaustive research, mugging up online as to what the process involves, reviewing past deals and dealmakers, and asking advice from those who've been through the fundraising wringer. Founders can discover how investors operate, and vice versa, saving time and energy by being prepared.
Due diligence in fundraising is ultimately the process of discovery, as founders and investors become familiar with each other and their business practices. It's never going to be a cakewalk and will definitely involve protracted discussions, but it need not always be painful. If you would like a callback please do contact us and we'd be happy to talk.