Due Diligence: How to Close the Deal With a Venture Capitalist

Receiving a term sheet from a VC investor means you are one step closer to securing financing. But there are still steps a VC must take before transferring funds: These include performing due diligence, which leads to drafting formal investment agreements.

Deals can fall apart in their later stages. As a founder, you can increase your chances of closing the deal by preparing well for due diligence, becoming familiar with the reasons that deals often go awry and taking proactive steps to encourage a close.

What is due diligence?
According to BusinessDictionary, due diligence is the “duty of the investor to gather necessary information on the actual or potential risks involved in an investment.”

The VC’s legal team will request information about the company’s financials, outstanding contracts and agreements, employees and management, capitalization table and intellectual property.

There is no standard length of time for the legal due diligence phase. It can range from “a couple of weeks if the deal is simple and if all parties are quickly aligned, to months for a complex deal,” VC Clement Vouillon wrote on Medium.

How to prepare for due diligence
Startup launchpad MaRS recommends choosing a team member to prepare due diligence paperwork using a checklist of the information that VCs commonly want to see. (You can find plenty of these checklists online.)

“Having due diligence binders ready will demonstrate to the potential investor that you are prepared. It will also speed up the review process,” the MaRS blog states.

Reasons VC deals fall apart
As an entrepreneur, it’s wise to learn about common mistakes that can jeopardize a deal’s progress during due diligence.

Nick Hammerschlag of OpenView Partners identifies reasons why a VC might pull out at the last minute in an article for Scale Finance, some of which are summarized below.

Inaccurate information
If VCs discover inaccurate data while performing due diligence, it could cause them to pull out of the deal. Founders should avoid overpromising on product development, exaggerating the company’s customer base or breadth of partnerships and misrepresenting revenue, growth rates or other financials.

Of course, most business owners don’t purposely misrepresent data. In any case, it’s best to be honest about company details from the start of your talks with a VC, as discrepancies will be brought to light during legal due diligence.