8. What do I need to provide for due diligence?
Note: this is Part 8 of Fractionalist’s Startup Fundraising Series for Early Stage Companies.
Be ready for due fundraising diligence ahead of time
When you agree on a term sheet, you'll head into due diligence with the firm you signed onto. This doesn't mean funding is guaranteed; you still have to make it through diligence. This is where you want to make sure you share everything under the sun about the company-- even the bad stuff.
Diligence comes with a lot of documentation, preparation, and paperwork. Getting ahead of these tasks make the potentially stressful time of closing a round a little easier.
Good to know
Ideally, you have incorporated as a Delaware C-Corp and have elected your board, sorted out your bylaws and Founder Stock Purchase agreement, and filed your 83b elections, etc. If you haven't done those things, then hop to it.
When you're going into fundraising, you'll want to make sure you don't have a backlog of equity grants waiting for board approval. This is especially critical when you're doing a priced round as your grant holders will be wanting the lower price before the investment round is closed. If you don't get to this it reduces potential upside for employees, and may result in you having to increase their compensation after closing the round. It's easy to do the board consents on these things through your legal counsel, so just go ahead and get it done.
Internal due diligence
There’s a lot of value in gathering the material you need for due diligence before you need it. It gives you a chance to catch a potential red flag (and fix it!) before an investor does. Your company doesn't have to be perfect, but you should have a good working knowledge of how your business is operating. Big challenges could put your deal in jeopardy or impact your valuation.
Setting up a data room
I keep copious notes and records about incorporation and have a basic data room ready to roll at all times. A data room is a secure, organized online space where you can share files with the investor team. It can be as basic as DropBox or DocSend or a tool like FounderSuite or Visible.
Any changes to the company, board consents, board meetings, etc I just update the information directly into the data room. When I'm ready to share it with a firm for due diligence, I clone it and share accordingly. Once it's shared, then the venture firm's team will start to dig in and will likely have a lot of questions for you. Yes, they will look through all of your incorporation documents, they will review your financial model, and they will call you out on things that come up. It's their job to do this, so make sure you have your ducks in a row and more importantly respond quickly to requests. From the time you sign the term sheet, you usually have 30 days to close and you'd be amazed at how quickly that time goes.
Elements you'll want to make sure you have in your data room include:
Corporate documents - certificate of incorporation, bylaws, founder stock purchase agreements, all minutes of directors and shareholder meetings, written board consents
Customers: Whether a spreadsheet, signed contracts or entries in your product database, you need to provide a list of who your customers are. This should be basic details like name, how long they have been a customer, monthly value and if it’s a long-term deal. It’s also helpful to get a few customer references prepared ahead of time. Nothing makes an investor happier than for you to do customer intros minutes after they have asked.
Financials: Actuals ideally pulled from your accounting software as well as any financial projections. For projections, you usually want at least 3 years out, but for an early stage company these are a guess at best. Investors know that, but have a rationale to back up your estimates.
Material agreements: advisor or consulting, terms of service, privacy policy, property leases, any agreements in excess of $25k, debts, insurance policies, judgements, joint venture or partnerships, management service or marketing, etc. Basically anything that has a material impact on the company.
IP: trademarks, copyrights, domain names, patents, etc.
Information regarding disputes and potential litigation. Hopefully you don't have this, but there are times when co-founders exit or there are disagreements with former employees. Always disclose it.
Employees: standard offer letter, list of employees, salary and benefits, employee handbook, 401k, stock option plans, foreign employees listed by country with any benefits provided to them.
Cap table: You can use something like Carta to manage your cap table. This should have ALL of your grants; employee stock options, founder shares, advisor stake, etc.
The more buttoned up on due diligence you are, the better off you’ll be.
Download our Sample Due Diligence Checklist to kickoff your data room.
What’s next?
This is part of the Fractionalist Fundraising Series for Early Stage Founders. We always appreciate feedback on the series and we're always here to help you with your fundraising efforts.
Fractionalist helps early stage companies navigate the challenges new companies inevitably face with a team of experienced CxOs you can leverage at a fraction of the cost.