Due Diligence Checklist for Venture Capital Deals

due diligence

Nine out of ten startups fail. Those aren’t easy numbers to swallow. It can be overwhelming to know exactly what you need to research in order to avoid as many venture capital deal failures as possible. Doing your due diligence is well worth it. Investors who devote at least 20 hours to the due diligence process see a 500% return on their investment

As experts on portfolio management, we’ve identified the nine areas where you can focus your time and efforts. By putting a little elbow grease into each of these areas, you’ll be able to identify red flags and weed out investments that are likely to sour. 

To help your firm navigate through the due diligence process, we’ve created a checklist where you can track your progress and evaluate each investment’s quality. The checklist outlines the information you need from the company your firm is considering investing in, tasks your firm needs to complete, and key questions that need to be addressed.

[Download the Checklist]

No matter what type of companies you are investing in, there are specific things you need to explore to create the best holistic view. 

Below are more details on each area and an explanation of why each is key to your final evaluation.

Leadership Assessment

The people running the business are vital to the company’s success. A few bad apples can spoil the whole bunch, even if there are a few rising stars on board.

To start your research on the leadership team, you’ll need resumes and professional references. It’s also helpful to request information on the board members and advisors to ensure they are suitable and committed. 

Not only will you want to review resumes and interview references, but it’s recommended to gather additional information from blind references. Use LinkedIn and other professional networks to identify former employers, clients, investors, or anyone else who could provide an alternative view of the team. 

Spending time with the leadership team is always worth it. Assign firm members to interview and shadow the CEO and executive team to evaluate integrity, track record, and required skill competencies. 

You’ll want to think hard about if they have the skills for where they are headed as opposed to where they have been. It’s also a good opportunity to identify the key hires needed to address any skill gaps. 

Technology, Intellectual Property, and Product Roadmap

Even with good people, a bad product won’t go far. Before you dive in, your firm must assess both the technology, intellectual property (IP), and product.

Make sure you request descriptions of the technology and product, any relevant technical publications, patents, related IP info, product roadmaps, and a list of competing technologies and commercialization status. This information will give your team a well-rounded view of where the product currently stands and what its potential is. 

You’ll want to meet with the technical team and assess their qualifications along with any critical technologies, tool choices, and scalability of solutions. Do they have the know-how and support to achieve the product roadmap? Every company comes with technical risks, so make sure you know what they are. If superior technology is on the horizon from a competitor, that could be a deal-breaker. 

Due Diligence Regulatory Strategy

Regulations can halt operations overnight and you can kiss your investment goodbye. Businesses that ignore regulations, no matter how attractive their product or people might be, are extremely dangerous. 

If you want to invest in a business, make sure they have a relevant regulatory strategy and request their status of dialogue with regulatory authorities or copies of relevant communications. You’ll want to assess if the company’s financial resources are sufficient to implement the imposed regulatory plan.

It’s best to interview experts to assess the regulatory climate and evaluate the proposed regulatory pathway. Is the company’s plan achievable? There could be remaining regulatory risks that the company isn’t considering that experts would recognize. 

Customer Need and Go-to-Market Plan

Most go-to-market plans that fail do so because they don’t start with customer needs. The plans don’t account for how customers will ultimately use the product or evaluate the product’s success. It’s a detrimental mistake for a company to build a product before figuring out the marketplace.

To avoid these pitfalls, ask the company to provide your firm with their in-depth go-to-market plan, partnership details, sales pipeline strategy, current marketing or distribution agreements, and references for customers, prospects, and partners. 

With this information, you can assess whether their plan is reasonable and confirm the customer demand and likely adoption rates. Beyond verifying the customer needs, does the company understand the customer’s buying priorities? Is their product necessary or just a “nice to have”? You should also be able to uncover any major risks in market awareness, customer adoption rates, and the sales cycle. 

Uniqueness and Competition

Is the company well-positioned against competitors? Even first-to-market companies can only enjoy the limelight for so long. Make sure you know the competitive landscape before you make a venture capital deal with a startup. 

Firms will find it well worth their while to dive into the company’s competitive analysis, including the market share and relative strengths and weaknesses. You’ll want to investigate whether the founding team is well-informed about their market and place in the industry. If they are unaware of key issues, it is a bad sign. 

Due Diligence: Market Size and Opportunity 

A deeper market assessment can uncover errors in market share projections and remaining risks in market development. 

To do a proper assessment, ask the company for access to market estimates that are properly segmented down to a reasonable addressable market segment. They should also be able to provide published market data and industry reports by segment, vertical, and/or geography. 

Industry experts can help fill in the gaps so firms can assess realistic market opportunities and product fit. 

Financial Projections and Funding Strategy 

Finances are the life-juice to companies. Without the proper funding, startups can’t get off the ground. Does their balance sheet make sense and are their financial projections reasonable? Make sure the companies you invest in are aware of their financial risks and realistic about their scaling expenses. 

Ask the company in question for their current balance sheet, historical and projected financials, fundraising history, records of used funds, and future financial needs and assumptions. This information should give your firm a solid foundation for assessing financial health, now and in the future. 

Exit Strategy

As an investor, you know that the exit strategy plays an important role in your potential return on investment. 

The company should have an exit strategy that they can share. It’s also helpful to acquire a list of potential acquirers and comparables. Discuss the exit strategy with the CEO to assess if it’s realistic and model exit multiples under representative scenarios. 

For an exit strategy to work, you’ll want a CEO that is a well-networked thought leader. Plus, there should be exit goal alignment between the CEO and their team. 

Company Structure, Deal Terms

Before it’s a done deal, you’ll want to look at the venture capital deal terms with a microscope. Pre-existing agreements, a complex shareholder structure, previous loans, or informal promises can become showstoppers. 

It’s vital to closely review the company’s documents of incorporation, capitalization table, and proposed deal terms. There might be obligatory changes to the legal structure or issues with prior agreements. This is the time to propose deal term changes and negotiate.

Startup Due Diligence = More Lucrative Venture Capital Deals

Embarking on a relationship with a startup before doing the proper due diligence is a risky move for any investor. The time it takes to do the research is well worth it.

If your firm can gather all of the information listed in the checklist and answer all critical questions, you should be well prepared to make an intelligent and informed decision about investing in a startup. Feel free to reach out to our team if you have any additional questions.

A traditional crm was built for general ‘customer’ scenarios

Software platforms have made the world a better place by making work a better place. Indeed the world is better off when people enjoy their jobs even marginally more, and workplace applications on big CRM platforms like Salesforce.com have done that and much more.

But the potential that platforms like these offer presents diminishing returns: once the platform provider has engineered too many industry specific components into its platform, its usefulness for other industries begins to be threatened, and with that so do the usefulness of the component tools built into the platform.

So it is with the CRM category that Salesforce.com has defined: it is generic enough to work for many industries, and yet still offers the potential for others to round off the edges and nail more vertically-oriented and extremely tailored software solutions.

Private capital markets are actually a great demonstration of this dynamic. Where generic CRM platforms simplify — appropriately so — to assume there’s a business, a customer, a sale, and service of that customer, there are a few industry-specific pieces that are missing.

Take for example, that investors become customers by investing through legal entities the GP raises. It’s a subtle but important nuance that just doesn’t make sense at a platform-as-a-service level (because it’s overly complicated for a simple one-time sale that many industries require), but which can easily be added without 10 years or software engineering. Once provided, the rest of the platform’s components become tremendously powerful again and you’re set to take over the world.

As a traditional CRM in our pillars methodology, these nuances must be present to properly account for investors in these legal entities, potential target companies and which are owned by these entities, the context of all interactions with these parties (as well as the appropriate overlap, ie co-investments), and how you’re arriving at finding these opportunities on both sides of the equation, such that you’re able to piece together what’s effective and what’s not. Not just because we say so, but because these are the very relationships and data that are key to the motivation behind a CRM in any industry.

It’s critical, too, that the valuable publicly-available information that helps to enrich CRM systems and save users painful steps of entering it themselves is fully-integrated at the platform level.

Again, look no further than the 3,000+ pre-built integrations that Salesforce.com — the creator of the CRM platform concept — has at a platform level to do so, and which only exists by way of holding just short of overly-specifying certain industry workflows that would present challenges to properly integrate.

Stakeholder reporting and communication (investor relations) draws on a range of datasets

The traditional “customer service” model of CRM systems once again makes overly-simplified assumptions about the customer relationship when applied to private capital markets.

In fifteen years I personally have yet to hear the terms “warranty” or “service call” in this market because it’s just not the same. But make no mistake, as uncomfortable as it may be to say aloud, customer service is more important now than ever and it’s constantly happening; the industry is, after all, considered to be a financial “service”.

As it turns out, that service is primarily information-based — it’s driven by data and takes the form of reports and analysis that drive decisions, and then end up again in investor-facing reports and analysis.

The foundational elements of a private capital markets CRM must be built such that they accommodate this data (like we discussed above), but so too that it can accommodate additional supporting data that investors (customers!) need in the context of service.

Oftentimes this supporting data — financial metrics and time-based values, for example — is believed not to meet the traditional definition of CRM and the natural thought is “well, better do this in Excel!”.

While I happen to believe Excel is still the greatest software application ever built, its introduction to this value chain we’ve discussed herein actually creates the problem many firms suffer from: key data needed to provide customer service (again: effectively the entirety of a firm’s reports and analysis) is now in disparate systems and detached.

Both of those dynamics are important and distinct: not only is this supplemental data disparate, but when brought together there is no logical association that can be made between the two data sets.

Allow me, then, to make the point very simply: not only can this financial and time-based value data (you may be thinking about is as “portfolio monitoring” or “accounting”) be a part of a CRM, it is arguably the most important part of a CRM because it’s at the core of what providing service to the customer entails — information that comes out of data!

Firms need a digital method to engage stakeholders (ie investor portals)

Investor portals are not new; in fact, for many of us — including myself — they conjure up horrifying nightmares in which we’re aimlessly guessing at folders to find the newest document we need.

So in lies the opportunity: not only have the portals we’ve come to hate not simplified the process of acquiring information, they’ve failed to create an entirely new experience that is “customer service” driven.

To be fair, this is not a B2C market where you’d be long out of business for not having focused on customer service and thus the customer’s technology-driven experience. But don’t expect to be around too much longer if you aren’t thinking about this shift.

Today’s institutional investors increasingly expect this same consumer-like experience, and a massive opportunity is being missed by not providing it. It’s not about providing them the experience they desire; it’s more about the ability to measure engagement that is had in return.

Put simply: what’s keeping the market from providing this experience is the availability of the information that’s required to create the service that provides the experience.

If you’ve hung in this long, you know that by focusing on your CRM, you have the data that’s required to manage the customer relationship and the technology-driven experience through which that information is shared to create a differentiated and opportunistic customer experience.

due diligence