Start-Up Financing: Due Diligence Is a Two-Way Street

When launching a new venture, it can be tempting to accept start-up financing from anyone who offers it.

However, entrepreneurs should always take the time to get to know their potential investors when it comes to start-up financing. After all, you will likely be married to them for several years. So while investors are checking you out, it is important that you do the same!

When conducting due diligence for start-up financing, there are a number of issues to consider. Most importantly, are these the type of people you want to work with? If your personalities do not mesh well or the investors do not support your vision, your company will likely face a bumpy road. For example, getting their cooperation in documenting future corporate financing issuance approvals or employee and director stock option plans could prove difficult. Furthermore, changes in corporate structure or new preferred stock authorizations brought about by new opportunities or new IRS or SEC guidance may not be appealing to you.

When looking for start-up financing another thought to consider: do the investors bring value to your company? This is where their track record and business experiences come into play. Before accepting their securities purchase agreements and payment, you should feel confident that your investors can deliver if they have displayed that they can bring additional resources, expertise or contacts to the table.

Tips for due diligence

Below are a few tips for conducting your due diligence:

• Research the firm/individuals online: The Internet can provide a wealth of information about potential investors for start-up financing. Perform a Google search (including for litigation, SEC filings, FINRA affiliations and proceedings), check out their firm’s website and check out their references.
• Test the chemistry: Your interactions with the investors should not be restricted to formal meetings. Grab a coffee or beer outside of the office to better assess whether they will be a good fit with your company. You don’t have to be best friends with your investors, but you should be able to form a productive business, or at least, shareholder relationship.
• Check prior investment relationships and results: Get the names of other entrepreneurs/portfolio companies who have worked with the investors and talk to them directly. While the startup’s level of success is an indicator, also ask about the investors’ strengths and weaknesses. Were they responsive? Did they follow through with what they said they were going to do? Were they difficult to deal with, tardy in responding, or demanding additional unwarranted considerations?
• Do the math: It is important to determine whether the investors will be able to deliver when it comes to future rounds of funding. Issues to consider include: how much funding is available; how much time does the fund have left; and how do the investors secure additional capital?

Remember, you will likely be in a long-term relationship with these investors, with few options for a “divorce.” You need to know you will be able to work together for better or worse.