Due diligence
doo DIL-ih-jens
The investigation process investors conduct before finalizing an investment to verify a company's financials, legal standing, and claims.
Due diligence is the investigation that happens between signing a term sheet and closing the deal. The investor verifies everything: financials, customer contracts, IP ownership, employment agreements, cap table accuracy, compliance, and pending litigation.
For early-stage companies, due diligence is lighter (days to a couple weeks). For later-stage companies, it can take 4-8 weeks and involve outside lawyers, accountants, and consultants. The investor is looking for red flags: undisclosed liabilities, IP ownership issues, customer concentration risk, or financials that do not match what was presented.
The best way to handle due diligence is to be prepared. Keep your corporate documents organized, your cap table clean, your contracts signed, and your financials accurate. Companies that struggle with due diligence signal to investors that their operations are sloppy.
Examples
A VC firm conducts due diligence on a Series A candidate.
The firm's associates spend two weeks reviewing: financial statements, customer contracts and retention data, employee agreements and IP assignments, corporate formation documents, and the cap table. They call five customer references. Everything checks out.
Due diligence reveals a problem.
The review discovers that a former cofounder never signed an IP assignment agreement. They left the company 18 months ago. The investor pauses the deal until the company resolves the IP issue with the former cofounder. It takes three weeks and a legal settlement.
A startup creates a data room in advance.
Before starting fundraising, the CEO organizes all corporate documents in a virtual data room: formation documents, board minutes, financial statements, customer contracts, employee agreements, and IP filings. When the term sheet is signed, due diligence starts immediately.
Frequently asked questions
How long does due diligence take?
Seed: 1-2 weeks. Series A: 2-4 weeks. Later stages: 4-8 weeks. The timeline depends on how organized the company is and whether any issues are found. A clean company with organized documents closes faster.
Can a deal fall apart during due diligence?
Yes. Undisclosed liabilities, IP ownership issues, customer churn that was not disclosed, legal disputes, or financials that do not match the pitch can all kill a deal. Transparency during fundraising prevents surprises during due diligence.
Related terms
A non-binding document outlining the key terms of an investment, including valuation, board seats, and investor rights.
The estimated worth of a company, determined during a funding round by negotiation between founders and investors.
A spreadsheet or tool that tracks who owns what percentage of a company, including founders, investors, and employees with stock options.
A form of private equity financing where firms invest fund money in high-growth startups in exchange for equity.
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