8 Startup Due Diligence Questions You want to Be Asking
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Due diligence for a startup is something of a contradiction in terms if you think about it. It’s a process that aims to give the technical, legal and financial grounds upon which a startup can gain investor support. Yet the process of getting a startup due diligence portfolio up and running is a labor intensive and greatly time consuming one that startups, trying to keep margins narrow, often lack the resources to properly do. With a reported 47% of investments in startups falling through due to unsatisfactory due diligence, how is a company to beat the resources conundrum? How is a startup to get its ducks in a row to land an investment?
The answer lies in the value of knowing the due diligence craft. Knowledge is power and knowing how to prep accounts for half of your potential success.
The following is the short and long of what you need to prepare your startup for a due diligence process. It begins with a call to action to founders and management teams to stop marketing their companies through rose-tinted lenses when speaking to investors and VCs and ends with a realistic checklist of what institutional investors are actually looking for.
CTOs step up to the plate – Preparing your startup for due diligence
Archive, archive, archive. Be prepared to show documents dating several years back and know that explanations about missing data will not be looked at kindly.
Since startups are tech based businesses, keep in mind that your trademark technology likely comprises your startup’s greatest asset. Be prepared to describe how your technology works, prove its scalability, and offer performance indicators. You will also need to show how your technology fares as compared to your competitors in the field.
Be very ready to answer the following eight questions.
1. Do you have a technology roadmap?
A clear vision and a roadmap are paramount to the success of any company. This perspective should be shared by your CTO and CEO. Your roadmap should be broken down into time frames, with attainable goals set for the next 6-24 months. When it comes time to seek an investment your startup should already have satisfactory proof of concept (POC) to share with your potential investors.
2. Does your product have an architecture and an infrastructure?
First off, the answer ought to be a resounding “yes!”. If your product lacks architectural specifications, no right minded investor will give it the time of day. Now that we got that cleared up, the question becomes how to present your product infrastructure. The answer is with detailed specifications. Specs are the name of the game here and investors expect to see them.
3. Do you have documentation and specs?
Do yourself a favor, don’t get passed over because you haven’t taken the time to write out the specifications of your product. If you haven’t done it already, this is the time to invest in a technical writer who will interview the CTO. The technical writer may also find it useful to talk to the entire tech team under the company’s CTO and produce the kind of document that will detail every function and operation of your product.
4. Let’s talk workflow
No startup due diligence is going to overlook how your organization goes about its business from a technological standpoint. Most likely you already have a workflow in place and it’s just a matter of documenting it. Worst case scenario, you have somehow gotten by without a workflow until now, in which case now is the time to instantiate one before investors write you off as being too ad hoc and unserious.
When detailing your workflow, consider your deployment process. Answer questions about your staging environment. How reliable is it and how secure? Does your production cycle have roll-back capabilities? Can specific features or elements be deployed individually, or do you need to republish the whole code every time you want deploy something new?
5. How versatile is your API?
This is a big one because it gives way to how capable your code is of integrating with third-party products. Your software’s “extensibility”, its ability to integrate with other software, drives its market value up. Investors are on the lookout for versatile products that easily and seamlessly combines with other products, serving as a major selling point when marketing your software product. Be prepared for questions of adaptability and flexibility of integration to be on your investors’ minds.
6. Tell them about your testing capabilities
Your investors know that testing is a mandatory part of the production cycle. They’ll want to know how you test your code for both security and quality purposes. Be prepared to talk about your QA process a well as the tools you have in place for security testing your proprietary code as well as your open source inventory.
7. Let them see your bill of materials
Another thing you need to have ready is your software inventory. During the startup due diligence process, startups often reach out to us asking that we generate for them an open-source bill of material (BOM). We will do this for the open source components in the code, yet you will need to do the same for your proprietary code. Ultimately, investors will want to see all the elements that comprise your commercial product.
8. Looking to the future: Scalability and agility
Investors want to make money. Pure and simple. Your startup’s ability to make them money is dependent on how it fares as compared to its overall industry marketplace. Startups these days are more agile than ever before, and you will be required to prove adaptiveness, continuous improvement of your product, rapid response to change and fast release rates. That and more, investors will expect your fast delivery not to hurt the increasing quality of your product and its continuous improvement. Finally, your product needs to be able to grow at scale while maintaining these agile features. Not a simple endeavor, we agree. But nevertheless, a necessary one in today’s tech investment climate.
A word to the finance, legal, and marketing teams
Yes, this is a startup due diligence. So yes, all eyes are on the CTO, VP Technology and their teams to produce the crux of the due diligence paperwork. But other teams are not off the hook and there is work to be done on their parts too.
Basic information about the company’s managing team and board of directors will need to be issued. This will be followed by a list of the startup’s shareholders, creditors, suppliers and other business affiliates. Investors are likely to want to see an organizational chart to help visualize the operation. What follows are legal documents including intellectual property and trademark seals, documentation of the patents that protect your IP, list of domestic and foreign jurisdictions in which the startup operates, as well as a summary of past and present litigation.
From the finance team, be ready to serve up documents of mergers and acquisitions, borrowings, loans, liens and other forms of indebtedness. Also have on-hand a list of your financial commitments including purchases, salaries, rent, overhead etc.
Finally, a word to the marketers on your team. Have all your press releases documented and recorded. You should be able to show records of news segments, podcasts, interviews and mentions issued by or with respect to your startup.
Take a deep breath – It can be done
The due diligence process is by no means an easy one, but it can be done and it should be done well. If your investment goals are realistic and in line with your company’s current profile, a well executed due diligence is likely to grant you the cash injection you need.
Even if the investment falls through, the due diligence process will not be for not. An in depth breakdown of the legal, technological and financial components of your business is always good to have. Even for your own use.
Try not to think about it as an exhaustive list of paperwork, but rather think of yourself an assessor trying to evaluate the worth of your own company. What would you like to see to make a valuation?
