What Entrepreneurs Need to Know About the Due Diligence Process

Picture1Getting through the due diligence process successfully and efficiently is an important challenge to entrepreneurs who are fundraising.  We interviewed Mike Chen, the Director of Due Diligence at the Alliance of Angels in Seattle to get his advice on this important topic. Mike has worked at Fortune 100 corporations with more than 23 years of experiences in corporate business development, digital innovation using new technology, contract negotiations, and strategic sourcing. He is also an active angel investor who advises high-tech startups in the greater Seattle area.

What are the steps in due diligence when an entrepreneur is working with an angel group like the Alliance of Angels?

Each angel group has their own process. At the Alliance of Angels (AoA), there are specific steps that we undergo in the due diligence process. A few days after the pitch presentation at our monthly member meeting, the investor deal lead or myself will have a 15–30-minute intro call with the entrepreneur to establish a connection and to coach them on what documents to include and questions to expect from our investors. Then, we have one or two kick-off meetings with the entrepreneur(s) and the Alliance of Angels members potentially interested in investing. In these meetings, AoA members will ask questions directly to the founders about their pitch. These meetings typically go on for one hour. After these meetings, we will discuss internally, decide Due Diligence (DD) focus areas, and assign members to conduct different aspects of DD research.

How long does the due diligence process take – from the angel group member meeting to completion?

The due diligence process from different angel groups may vary, but speaking from AoA’s perspective, it is about 4 to 6 weeks from the first DD kick-off meeting to a decision from our members.  In recent months we are averaging 4.5 weeks.  It is important to note that this decision is whether the individual members will invest or not (with a soft $ commit), not when the money is in the entrepreneurs’ hands. That process may be delayed by other investors or legal documentation, for example.

What is the role of the investor Deal Lead?

The Deal Lead is the main face of the group. Their role is to keep communication open with the entrepreneur and to act as the program manager of the angel group. The Deal Lead schedules meetings between the entrepreneurs and angel members, and generally keeps things moving along. The Deal Lead does not do all the due diligence; it is a high-level position that assigns different group members areas of due diligence. There is a big benefit to being the Deal Lead as it provides a great opportunity to get to know the entrepreneur better and the interested angel members as well.

What should an entrepreneur do if a Deal Lead does not emerge?

The entrepreneur should not panic if no Deal Lead emerges. It does not mean there is no interest in their company or idea. If there is no Deal Lead, it will most likely mean the entrepreneur will interact more directly with interested angel investors simultaneously for certain areas of due diligence. At AoA, either myself or one of our other staff members will often take over to take the lead if no Deal Lead emerges.

What is a Deal Room and why is it important?

The deal room is a place for all the important documents that an entrepreneur uploads for the angel investors for due diligence purposes. It is important as it helps investors make decisions easier and quicker.  Having a well populated deal room can save the entrepreneur a tremendous amount of time as it provides commonly requested information that the investor can access on their own thereby relieving the entrepreneur from having to have repeated conversations on those topics.  Some entrepreneurs keep a running FAQ document in their Deal Room so that common questions can be answered and updated during the process.

What documents should the entrepreneur prepare in advance and have available in the company’s Deal Room?

  • Pitch deck, financial documents such as the company’s prior and forecasted P&L, balance sheet
  • If possible: term sheet, cap table, patents
  • Market size
  • Documents that demonstrate traction: customer references, customer list, sample agreements
  • Competitive analysis (if available)
  • Company formation documents
  • Team member profiles (founders, key employees, board, advisors)
  • Some angel groups have specific due diligence forms that ask for more clarification as well.

How should entrepreneurs handle confidential information?

Entrepreneurs should withhold very sensitive information until members are serious about investing. At AoA, we will keep information confidential to ourselves and will not share with anyone outside of the angel group if the entrepreneur tells us to. We will only share at the point the entrepreneur gives us authorization.

What common mistakes do entrepreneurs make during due diligence?

The most common mistake entrepreneurs make is not providing all the documents needed for due diligence. It is important to provide as much to the angel investors as possible so they can make the best and fastest decision for the founders’ sake. Another common mistake I see is that entrepreneurs paint too good of a picture and only talk about the rosy stuff. My advice to founders would be to make sure you bring up the challenges you are facing too, so investors perceive you as being authentic and trustworthy. Lastly, I see entrepreneurs not give enough time for angel investors to make decisions. My advice would be to plan out funding needs well in advance to allow enough time for due diligence.

What additional tips do you have to be successful in due diligence?

Think from an investor’s perspective. Listen carefully to investors’ concerns: will the company survive four or five years? Will the company grow rapidly? What is the company’s competitive advantage? Lastly, what kind of exit strategy does the entrepreneur have in mind? As a founder, make sure you have answers to these kinds of questions and think like an investor.

Where can an entrepreneur find more resources about the due diligence process?

We provide excellent resources about due diligence on the Alliance of Angels website here. You can learn about specifics of due diligence as well as extra resources that may help on your entrepreneurial or investment journey.

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