Written by: Magnus Ernegård, Executive Contributor
Executive Contributors at Brainz Magazine are handpicked and invited to contribute because of their knowledge and valuable insight within their area of expertise.
Once the Angel investor and you have signed the Term Sheet, you will likely begin the Due Diligence ("DD") process now, which is an inspection of your venture. It means the Business Angles and their advisors review your venture and its documentation to confirm any stated facts by you as the founder or team members. Part of this process is in detail to check the financial situation, which the investor himself usually does. For some ventures, a technical DD is carried out if this is relevant to the operation. The investor's legal representative usually does the legal part of the DD. Your Business Angel won't simply rely on the information you and your team provide them. They will most likely perform external and independent checks like interviewing former and current employees and partners or contacting customers to get feedback on your product and their experiences with your venture. Sometimes Angel investors or its legal representative search about the Startup venture in the Tax Agency, in the Companies Registration Office, the Enforcement Agency, Courts in the region where the Startup venture operates, and the Domain Register. They could also check patents and patent applications in the Patent and Registration Office. Furthermore, the potential investor can contact industry-specific organisations for cases where specific permits are required for the venture's operation. So, get in touch with these organisations well before the DD process starts and check the information yourself before your Business Angel does.
So, you now came to the vital Due Diligence-process, which can destroy the whole deal if not appropriately managed. Some entrepreneurs mistake doing very little to prepare for the DD and have a pretty deficient documentation structure. It would be somewhat discouraging for you and the investors to begin finding issues and significant shortcomings, realising your story is not as complete and attractive as the Business Angels first thought. A failed DD process can significantly devalue your Startup for a long time ahead. So, as the founder, together with your team, you must exhibit total transparency since any discrepancies discovered may jeopardise the whole deal. So always tell the truth. Even a small lie can destroy trust among you, your team, and the Angel investors (or VCs). And that when you are right at the finish line with your funding process. Nobody expects everything to be perfect in business life, especially not in Startups, but you should have a plan to face things going wrong. As an entrepreneur and founder, you should show that you can manage uncertainty and potential upcoming crises.
But you have had a good order and structure during your Startup journey so far, so you will also impress the Angel investors in this part of the process. You survived and managed the Term Sheet negotiation well, and now there is this one more hurdle before the investor's check could be handed over.
Your responsibility as a Startup seeking capital is to provide and fill a physical or virtual data room with all documents relating to the venture's operations and all information requested by the Angel investor and its advisers. DD is typically a pretty long process, and it could take a couple of weeks if you have all the documents ready and prepared. But gathering, organising, and systematising key documents and answering any irregularities in the material could take months. It could well be over 100 different files for an average venture to compile. So, the Angels will be excited if you have all the documents and information fast and efficiently available and thereby able to have all investors access to the same information material and at the same time. Several global players, including the most prominent data management service suppliers, provide document management systems that can be used for the DD process. However, most of these are based on archaic folder structures and are overly complex for what should be a straightforward early-stage funding round. That is why we at BridgeToAngels recommend and work with our partner DD-Ready based in Finland and operating globally. DD-Ready offers an innovative, intelligent and customisable tool that does away with the need for Excel and thousands of emails, all on one SaaS platform. It also provides templates, guidance and an entire network of partners and advisors that can help your venture get ready for Due Diligence and remain so at all times. In addition, their Virtual Data Room (1-click VDR) concept provides a stable solution for both you as the fund seeker and the investor. On the investor side, various investors have taken up DD-Ready and can even be branded to look and feel like the company carrying out the Due Diligence. Check out what they can offer well in advance before you start your DD process.
We still see manual paper checklists provided by lawyers or on the net, which are time-consuming, complicated, and easy to make mistakes. So, seriously consider going for the fully automated DD, which will provide a good structure including all your upcoming funding rounds and until the exit.
Like you, the Business Angels see a long-term business relationship, so it is worth your time as a founder to do the extra work setting up a proper DD structure and making the agreement a win-win deal for both of you. The DD work differs, of course, in its depths and width depending on where you are in your Startup journey. If the venture is in the very early stages, there is not that much to dig into. But some check-ups are more or less mandatory for the Business Angels to investigate, like any litigations, pending lawsuits, patent disputes, disgruntled team members, and all sorts of claims.
The Capitalisation Tables
One other critical area and a must to have absolute control of and that I would like to point out in the DD setup is the Capitalisation table. Your Startup's equity or ownership structure doesn't feel or first appear to be that complicated having a good grip on, but it could very well be. When your venture is in its infancy, it is more of "plain-vanilla" managing the Cap-table. But then you might get this complex ownership structure with several co-founders, Business Angels, Family and Friends, the team's option pool, different preferred share structures, anti-dilution rights, convertible debts, etc. Further, deals made with these investors and lenders may have other specific stipulations that will affect how your Startup is viewed in its funding stages. This might be even more complicated when new investors come on board and after additional funding rounds. So, the new investors will meticulously inspect the agreements between the venture and the previous early-stage investors during the DD. Consider using a secure and scalable Cap-table platform with analysis tools and modelling abilities to use from the start and the very first funding round until the exit. (We will elaborate more on the Cap-tables in a later article in the BRAINZ Magazine).
What to check?
Keep in mind that the objective with the DD is for you to share enough information so the Angel investors can make a favourable decision to inject equity in your Startup. But not that much for them to replicate your venture if the deal is not closed. Never forget that an investor can be a competitor in identical circumstances. So, check if your Startup venture is potentially competing with something or someone the investor now has engagement with or shares.
If you haven't already, which you already should have performed at the early pitching stage, make sure you, as the founder, have completed an in-depth Due Diligence on the potential investors. Investigate what their investment focus and portfolio look like and where the investor has previously invested? Examine which industries, ticket sizes, business models, investment stages, and geographical areas the investor has had. Perhaps you can check with other ventures who completed one or two funding rounds and where these Business Angels have invested and get information about their working style, engagement, and seriousness.
Many benefits for your Startup being audited
If you or the Angels investor find a critical deficiency in your venture that you'll need to address isn't pleasant but can be highly beneficial for your Startup's future. Most seasoned Angel investors are very experienced and well-oriented in building and scaling a venture and will be able to point out what your Startup deficiencies are and how you can address them. They very likely know every early Startup has some blemishes, and things will happen that cannot be foreseen, and mistakes are bound to occur.
From your perspective as a founder, you might see the DD as a pretty intimidating process, but do keep in mind that it's a normal activity and even an essential part of any Startup deal structure. You should see the Angel investors as a partner who wants to offer guidance and make your Startup journey better, more promising, and successful, not as someone trying to dig up dirt on your venture to cause it harm. Remember, the Business Angel is interested in your venture, which means they are at this stage of the process quite committed to the deal and have a favourable opinion about you and your team.
So, it can offer many benefits for your Startup being audited. The process provides an impartial and detailed assessment of your Startup and gives your venture a good breakdown of its strengths and weaknesses.
To sum it up.
Of course, we do not want to exaggerate the scope of DD in smaller Startups which cannot, of course, be compared with a complex M&A deal. Since the Business Angel is likely only to be interested in a minority share and not a complete acquisition, the DD process will for sure be less extensive.
But still, your Startup has an opportunity to put your best foot forward, to show evidence of outstanding organisational ability and well-structured business-operation skills. You will be able to strengthen the Angel investor conviction about you, your team and your Startup venture through a transparent, well-constructed and robust DD process.
Until next time. Keep on Starting up!
Magnus Ernegård, Executive Contributor Brainz Magazine
Magnus Ernegård has over 30 years of senior management experience from different industries in multinational industrial companies in various countries. Background in CEO positions, CFO, management consultant, production, business development, innovation, corporate governance, and entrepreneurship. Further, he has, over the years, gained Board and Chairman experiences from Boards within the Automotive, Logistics, IT Consulting, and Textile industries. Today, he is the owner and founder of the Startup support provider company BridgeToAngels based in Sweden and Denmark. Magnus has a proven track record in starting/developing businesses, company split, corporate exits, and organizational effectiveness. Magnus also serves as Advisory Council Member of Gerson Lehrman Group. He holds an MSc from the University of Lund, Sweden.
