What is Due Diligence and why is it important?

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Claims such as sales figures, growth percentages, and market size are all examples of claims that will be checked. Due diligence will also be done on the company directors to check that the leadership team is telling the truth and not hiding any skeletons in the closet that may impact the future of the business.

So, how can you prepare yourself for the process and ensure it runs as smoothly as possible?

Learn first how to prepare for Due Diligence

In this article, we will look at precisely what due diligence is and answer some of the important questions around the DD process. However, you also need to know how to prepare for and deliver DD when the time comes. Read how to prepare for due diligence to learn about warranties, the other stakeholders involved in the DD process, the preparation phase, the exact files you need to produce and for whom as well as how to close out the process.

Why is it important to conduct Due Diligence?

Investing in a business is a large undertaking, and is a legally binding process with many implications whether things go well (hopefully the aim) or not so well (it happens!).

It is important for investors to conduct due diligence because they need to be sure the company in which they are considering investment is at the stage they say they are and that the people running the company are who they say they are. It is also important to verify that any claims and factual statements made by the company are true and accurate.

Under what circumstances might you need to conduct Due Diligence?

DD is conducted when a person or company is looking to make an investment. Due diligence is also performed by crowdfunding platforms before allowing a company to raise on its platform.

You can expect due diligence to be performed on your business each time you open a funding round. Often the lead investors will perform the DD meaning investors that join the round on the back of the lead investment will not necessarily need to conduct their own due diligence and they will be happy to invest based on the DD conducted by the lead investor.

What can be the consequences of failing to conduct proper Due Diligence?

Failing to conduct thorough due diligence can have dire consequences for investors.

If due diligence is not conducted properly, it can result in investors investing their money into a business that is deliberately misleading or concealing information from them. This can result in substantial financial losses and/or reputational damage if an investor is deemed to have performed unsatisfactory levels of DD.

What does Due Diligence usually entail?

The process for due diligence can vary depending on who is conducting it but in general, it will consist of the investor requesting certain company information in order to see the evidence of what the company is claiming.

Examples of information that investors will want to see can include:

  • The full financial model
  • Organisational chart
  • Directors’ work history
  • Sales and marketing plans
  • Growth plans
  • SEIS/EIS confirmation

Once this information has been provided it is likely the investor will then come back with additional questions in order to dive a little deeper into the business. The process can often take 4-6 weeks to complete.

Is the process the same when crowdfunding?

Due diligence on a crowdfunding platform is slightly different as they conduct their own checks to make sure that any claim that is being made on the platform is accurate.

This process involves providing evidence to the crowdfunding platform by way of:

  • External articles
  • Financial statements
  • Employment contracts, etc.

These help to prove that each claim you are making is accurate and is not being falsified.

The crowdfunding platform conducts this due diligence early in the process so that each individual investor in the platform does not need to, but it can still be rigorous and time-consuming.

If you are looking to crowdfund we would recommend setting aside 2-4 weeks for the due diligence process alone. However, choosing the right partner to help you prepare for your fundraise can help ensure this process is less arduous & gets completed more quickly.

Can it be useful to outsource Due Diligence tasks?

It is difficult to fully outsource the due diligence process because all the evidence that will be needed will need to come from within the company.

You can, however, work with a fundraising partner who can help assist and guide you through the process so that you have the knowledge and expertise working alongside you to get the process completed as quickly as possible.

How to tell if you have completed all the necessary Due Diligence?

You will know that the due diligence process has been completed because the investor will stop asking for information and will likely move onto the final stages of the process which include getting a term sheet signed and shareholders agreement in place.

Runway Recap

  • Due diligence is an important part of the investment process and will be conducted thoroughly by investors so it is important to be prepared.
  • You can look to work with a fundraising partner who can help guide you through the process but overall it will be the business that needs to provide most or (if not all) of the information that will be requested.
  • The full process can take a while (on avg 2 – 6 weeks) so it is important to give yourself enough time to complete it.