There is no shortage of content discussing the due diligence process investors conduct on the companies they are considering investing in. The investor checklist does a deep dive into the company, including corporate compliance records, employment, finances and taxes, labor issues, business contracts, intellectual property rights, litigation concerns and the individuals behind the company.
At DCN I get to speak with founders all the time and have found over and over again, more specifically in the Cannabis industry, many are unsure of how they should go about this process; many others assumed a quick google search was all that was needed.
The reality is, all money is not good money, and not every investor is ideal for your business. You need to do your homework; you want to make sure that you know what you want from an investor, and what type of investors are in the marketplace.
On top of that, you want to thoroughly examine their current and past investments and take the time to speak with these companies they’ve invested in so you can get a better feeling of this potential investor and the value they bring.
First, what is due diligence?
Due diligence is the general term used to describe any background check on a company or individual to see if they are legitimate and suitable to do business with.
Basically, in this case, it’s checking that an investor is who they say they are and that they can help you in the ways they suggest they can.
This process starts, from the moment you connect with a prospective investor as that’s when you start forming an impression of them. However, you only need to formalize the process once you are sure they are interested and once the relationship progresses to the point of meeting and discussing deal terms. Once it gets to that point, then it’s a good idea to make sure you know exactly whom you’re dealing with.
How do I perform due diligence on investors?
Below is a checklist that you can use at a minimum to help guide you through your search for a potential investor:
Get a perspective from other investors. Of course, you need to discount any competitive investor positioning. You can even reach out to local investment group leaders, they will quickly tell you the strengths and terms of active investors in your area. If your investor is unknown, or peers offer no positive attributes, take it as a red flag.
Personally visit another startup funded by this investor if traveling is not available, then look at scheduling a conference call with at least 2-3 of their portfolio companies. Another approach is to ask the investor for references, looking for references that can discuss where their involvement has made a real difference and how it has lead to success.
Do your online research on investor visibility via Google, Angellist and social media. Start by checking the profile and credentials of investor principals on LinkedIn and industry associations. Check for positive or negative news articles, press releases, relationships, and support of community organizations.
Invite the investor to dinner or fun-related activity. Outside of work is where you can best evaluate the chemistry match, and decide whether you can enjoy and learn from the relationship.
Another major warning sign is if an investor asks for upfront fees before they invest. I have heard horror stories where entrepreneurs have been taken advantage of and have paid upfront fees and then the investor has disappeared. Fake investors will come up with all sorts of plausible reasons for the fee. These should be ignored without exception.
Conduct a routine credit and background check. Look for investor experience in your business domain, as well as evidence of integrity and trustworthiness. Check the content of the investor’s website, and pay particular attention to the source of funds.
Make sure you have an attorney familiar with startup equity investment deals. To get the terms you want, it’s better to start with your own term sheet. It’s even better to let the attorney do the negotiating since many innocent-sounding protective and governance provisions can have long-term negative consequences to you.
Below I have provided a list of top 10 questions to ask investors when moving the discussion forward:
When was their most recent investment and how much do they typically invest?
How many of its portfolio companies are in your market space?
How many of its portfolio companies have had successful exits?
How many of the portfolio companies still have their founders involved?
Does the investor have a minimum investment amount they usually invest?
Was there only one initial investment, or do they make follow-on rounds? How much time passed between investments?
In their previous investments, have they acted as a lead investor?
Does the key investor — whether an individual angel or venture capital partner — have actual operating experience?
What do the portfolio companies say about working with the investor?
After having this conversation, take a step back, analyze and ask yourself this one question:
Is this someone you wish to marry?
If not, trust your gut and move on. Avoid forcing a situation to fit. If, however, you can see yourself spending the next 3 – 7 years financially married with this investor, then move forward and proceed with caution.
Remember, this is your company and your future. This is an opportunity to grow, partner and succeed, so be sure there is a mutual attraction between you and an investor.
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