When examining possible investment opportunities, venture capital firms often use a due diligence procedure.
That means entrepreneurs and their businesses are scrutinized, and the startup team should be prepared to cope with it. Here are the 7 steps, as well as what entrepreneurs should know about them:
The first step is the preliminary screening, which determines whether the startup is eligible to be scrutinized at all.
When the founder and the investment analyst contact, the first phase of due diligence often begins immediately.
In many circumstances, the process begins casually, and the startup may be unaware of the level to which they are being reviewed.
The VC firm also conducts a preliminary examination of the startup’s business strategy, market possibilities, and management team during the initial contact with the founders. From there, the startup’s profile can be briefly analyzed and a judgment taken for more evaluation.
Now, after the screening, the investment analyst evaluates the startup’s product’s market size, rivalry, trends, and growth prospects.
The startup’s market share is studied to assess if there is a sufficient requirement for the product being provided. That is an extremely important aspect of the due diligence process.
Note that investors understand that there is no such thing as a “perfect market” to invest in, therefore they hunt for markets with tremendous prospects where they can fund companies looking for an ideal environment.
Even high-growth markets, however, come with their own set of hazards, such as intense rivalry, rapid technological change, and regulatory obstacles.
Also read, These 7 Signs Might Draw Venture Capitalists to You
VCs judge performance through financial research as well. It includes a review of the startup’s balance sheet, earnings and cash flow report, revenue, expenses, and estimates, as well as capital structure, which includes debt-to-equity ratio, customer acquisition model, and strategies for how the funds generated will be used (no investor wants to throw money away).
Founders must be ready to give complete and precise statements, well-reasoned projections, and confirmation of transparent accounting rules and practices to succeed.
After that is the task of analyzing a startup’s legal and regulatory compliance situation, as well as its prospective legal threats (If you don’t have legal and regulatory compliance, I suggest getting it ASAP).
The goal of legal due diligence is to discover and examine any legal or contractual concerns that may influence the investment’s value or the business’ capacity to function properly.
The startup needs to show a comprehensive understanding of its governance structure, contractual duties, and intellectual property, as well as a comprehension of the legal needs related to its business and a willingness to address any ongoing or potential litigation/disputes.
Technology evaluation and customer validation
The analysis of the firm’s products is the focal point of any due diligence exercise. The goal of product due diligence is to evaluate a company’s goods’ quality, distinctiveness, and market attractiveness, as well as its capacity to bring these items to market and scale its operations.
The product should not be the only one of its kind, nor should it be a panacea for the entire market sector; rather, it should truly satisfy the desires and tastes of its target clients.
This is confirmed through the customer validation procedure, which seeks input from users. In addition, the VC company investigates the startup’s technology to evaluate its quality, abilities, constraints, and scalability.
A technical investigation may include studying code, software architecture, hardware systems, and technological platforms, as well as user testing and assessing the company’s ability to interact with other systems.
Management assessment and character evaluation
VCs additionally pay close attention to the startup’s management team’s experience, talents, and track record to guarantee that it has the competence to carry out its business plan.
Furthermore, analysts inquire of industry colleagues about their experiences dealing with the founder. And nowadays it’s not even about how creative or popular the founder is, but about how one can guide the firm through phases of growth and development while adapting to changes in the market and business atmosphere, and here is where character comes into play.
Report on due diligence
Following these reviews, the VC analyst will prepare a due diligence report describing what they discovered and recommending whether or not to invest to the Investment Committee.
Therefore, before deciding to invest, the VC firm gains a complete grasp of the startup and its prospects for success.
An entrepreneur must grasp what is going on in the venture capital world. They must be mindful of the due diligence process and be willing to cooperate.
Many have probably heard about the controversies involving major funds, and none of the VCs want to be in a similar scenario. That is why a due diligence procedure is critical, particularly throughout the expansion stages.
Keep in mind that opposite due diligence is equally necessary and will make you appear professional: Examine the VC’s past and credibility as you and the VC will have an extended path to success together.
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