Terri and Jaqueline sit down over a cup of coffee (not bubbly) to talk about Terri’s approach to due diligence, why she does it, when she does it, and what she looks for. She also encourages founders to do their own due diligence on potential investors.
Terri talks about how founders should pull together a deal room in advance of fundraising to make it easier to share information with investors during the due diligence process. It sends good signal and looks professional.
Founders can’t be prepared for everything but have an organized and complete deal room will set a solid foundation and leave time to deal with the additional requests for information.
Terri describes a deal room and the importance of keeping track of who gets access to it. Create the structure and then add to it over time.
Terri’s level of due diligence depends the size of the deal, the size of her check, and if she is bringing other investors into the deal. She believes in right-sizing due diligence and has a checklist she works from.
Terri uses the due diligence process as an opportunity to build a relationship with the founding team.
Deal information: terms, term sheet, use of funds, milestones, existing investors in the round, side letters/special treatment. Terri cross checks this against what she has been told or what is in the pitch deck.
Financial: financial statements, projections, assumptions, management team, references, key personnel, board members and advisors, contact information, capital and equity structure both current and projected cap table, financial obligations, agreements and restrictions.
Organizational: entity formation and maintenance documents, founders, prior acquisitions or mergers, failed transactions, consulting agreements, compensation, advisors, contact information, facility agreements.
Intellectual Property/Technology: patents, copyrights, trademarks, proprietary invention agreements, license agreements.
Product Marketing and Sales: product list, marketing collateral, marketing plan, go-to-market strategy, anticipated customer acquisition cost, anticipated lifetime value of each customer, align to projections, major customers (to do reference customers), sales team, forecasts, backlog, pipeline, distribution channels and agreements, competition, production process and costs, suppliers, exclusivity, geography of suppliers or software developers, R&D projects.
Terri spends 4-6 hours to review all this information (with a glass or two of wine) and she enjoys this but has to set aside the time to do it. Her background as an auditor (financial and vendor) lends itself well to this work along with her experience negotiating agreements for herself and clients.
Terri prefers not to outsource this to someone else because she doesn’t do it very often and likes to get to know the company and the business through the process. She also uses the Q&A process to build the relationship and get a sense of what it is like to worth with the founder.
Terri also asks around and talks to other founders, investors, and might do background checks.
What should founders do as part of their due diligence? First of all, do it. Ask other founders and investors about them. Find out what happened when the startup didn’t go well as to how the investor reacted and either helped or didn’t. Make sure they are going to be a good fit; it’s hard to get rid of them later. Reputation of the investor is important because a bad investor on the cap table can be a bad signal to other investors.
As a founder, where does one start? Create the deal room and start to populate it with the static documents or documents as they are requested. For the dynamic documents, put in the most recent version.
Founders should not ask for a signed NDA from a potential investor; you have to assume good intent. If you aren’t comfortable, don’t share. Investors can’t keep track of all of the signed agreements and terms.
Final tips: investors should look at due diligence as an investment in supporting the value of the deal and the founders can see it as something to build a relationship with the investors. Founders should respond quickly to questions asked by potential investors and be transparent to build the relationship.
References in the Podcast
Women’s Startup Lab: https://womenstartuplab.com/
Venture Deals (online class): https://www.kauffmanfellows.org/online-course-venture-deals/
Brad Feld: https://www.linkedin.com/in/bfeld/
Jason Mendelson: https://www.linkedin.com/in/jasonmendelson/
Venture Deals (the book): https://www.feld.com/archives/2016/10/venture-deals-third-edition.html
Angel (the book): https://www.angelthebook.com/
Jason Calacanis: http://calacanis.com/
Laura Fleet: https://www.linkedin.com/in/laura-brookins-fleet-49aa9a54/
Y Combinator Series A Due Diligence Checklist
You can follow Jacqueline on Twitter @andYoureaGirl or go to her website at https://www.jacquelinesteenhuis.com/.
You can follow Terri on Twitter at @terrihansonmead or go to her website at www.terrihansonmead.com or on Medium: https://medium.com/@terrihansonmead.
Feel free to email Terri at PilotingYourLife@gmail.com.
To continue the conversation, go to Twitter at @PilotingLife and use hashtag #PilotingYourLife.