Due Diligence – What to Expect

You just signed a term sheet for your first round of venture capital.  Congratulations!  Now what?

While every fund has their own process and each deal works a bit differently, what you can expect between signing a term sheet and closing the round (to which I refer in aggregate as “diligence”) basically falls into four buckets:

1. Confirmatory due diligence.  What this means is the investor is switching gears from “why should I do this deal?” mode to “why shouldn’t I do this deal?” mode.  There is a pretty standard set of items the investor will request.  Click here for the generic diligence request list that Softbank uses.  Depending upon the stage of the company, there are usually a 100+ documents that need to be collected and delivered.  I’m a big fan of using to manage document delivery.  In fact, I recommend using it to deliver documents from the beginning of the fund raising process.  For example, when a VC asks for your “financial model” you should point them to Sharepoint instead of emailing the file.  One benefit is you can check who’s accessed the file and you can turn off access if they pass.  For $40 per month you can buy a hosted version of Sharepoint.  I’ve used this company before with good results.
2. Syndication.  For many deals, particularly the first institutional round, the full amount of the raise won’t be spoken for.  For example, if the raise is $8MM, the lead investor might be committed to $4-5MM.  Syndication is the process of finding one or more additional investors to complete the round.  If you had the good fortune of receiving multiple term sheets to begin with (and assuming you like one of the others) the easiest way to complete the syndicate is to invite those folks to participate on your newly signed term sheet.  Failing that, you should reach out to the firms with whom you got close, but not all the way.  The expectation is that the entrepreneur leads and directs the syndication process.  The good news is that having a signed term sheet (hopefully from a reputable firm) makes it a lot easier than getting the term sheet to begin with.
3. Documentation.  Generating about 2-inches of legal agreements codifying the investment.  Usually company counsel will take the lead on drafting documents; although it’s not unheard of for the lead investor to do the first draft.  You should ask that the syndicate use one law firm, but if they insist on each using there own, plan on the process taking a week or two longer than it would otherwise.
4. Closing.  Signing the paperwork and wiring the money.  Yeah!  It used to be that closings were held in person at some attorney’s office (at least that was my experience early in my career) but today that almost never happens.  The closing is usually held over a couple of days after everything has been agreed and then they sign and fax their signature pages to company counsel.  Depending upon how many signatures, it can take a few days to complete.

It is rare (although not unheard of) for a deal to fall apart after signing of a term sheet.  I did an informal poll of some VCs and found that less than 10% of early stage VC deals fall apart and fail to close.  The best thing you can do as an entrepreneur to avoid this is to ask the VC (ideally right before signing the term sheet) what remaining concerns they have and what diligence they expect to perform.  The more explicit you are in asking these questions, the more likely you are to avoid surprises on either side of the table.

Diligence typically takes anywhere from 30 to 60 days, although it’s not unheard of to go longer, particularly if the company and lead investor still need to finalize the syndication of the round.