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Fundraising Due Diligence: Why It Matters and How to Prepare

Updated: Apr 19

Tough economic times often come with a tighter fundraising landscape. As many startup founders have seen in 2023, this is certainly the case today. As a result, it’s vital for company leaders to put extra consideration into due diligence and being “fundraise-ready.” 


Founders can fall into the trap of preparing for due diligence on the eve of their funding round. Doing so runs the risk of causing unnecessary stress, costs, and delays in closing.


Here are some helpful steps you can take early on to better prepare for the process—and, by extension—your future.


What is fundraising due diligence?

Due diligence is an assessment of your organization from your potential investors, designed to scrutinize the risks of investing in your company, as well as the opportunities for your company to grow and have a successful exit. When companies are properly prepared for due diligence, the process can help demonstrate the potential value of the company as a whole and showcase your individual strengths as leaders. 


The more comprehensive the materials you can provide during this process, the better your startup will look to investors, and the more solid ground you’ll be on for that first round of funding. To help you prepare, we have compiled an example checklist of some essential documents that you should have handy in order to ensure investors have the most thorough and accurate picture of your company.


Why does fundraising due diligence matter?

As with many other startup activities, CEOs and founders are usually the face of the due diligence process. Your potential investors are using the due diligence process to gather information about your business, your team, and your product.


Here’s just a short list of some reasons why due diligence matters so much:


  • Your investors need to know what they’re buying and how much of the company they will get. If an investor can’t get a clear picture of who owns what parts of your company, and what their investment will get them in terms of percentage ownership, they can’t relay back to their investors – their limited partners – what they’ve purchased. 


  • The documents you’ll sign in the financing contain statements that you’ll be certifying as to the state of your company. The diligence process needs to provide a clear and holistic picture of the company’s assets, including intellectual property, team, and liabilities, such as potential lawsuits. Neglecting to include this information in diligence can cause legal issues post-closing.


  • You want to get your deal closed as quickly as possible. Questions and concerns that arise during diligence inevitably delay the financing’s closing date (and risk eroding investor confidence in the company). The more buttoned up and thorough a company’s information, the more likely they’ll be able to get through the financing process quickly and efficiently. 


4 tips to prepare for due diligence

Now that you understand the fundamental importance of the due diligence process, here are some steps that can help towards future fundraising success. 


Make sure you have a clean cap table

A cap table is a list of everyone who owns stock in your company and how much, as well as those who may not own stock now, but will have the right to buy stock down the line. A cap table will show people who own common or preferred stock, people who have options or warrants to buy stock, or a bridge note or SAFE that gives someone a right to preferred stock in the future. 


A cap table should be a living document—regularly updated and reviewed, and backed up by clear and complete documentation. Only then can it serve as the objective source of truth as to who owns your company and, thus, what an investor might get in return for their investment. Avoid having different versions of your cap table, or keeping your documents separate from your cap table data, by using an automated cap table.


Standardize your hiring process across departments

Standardizing your hiring process is just one example of how successful startups keep themselves diligence ready —treating it like a daily priority


Onboarding new employees has a direct impact on your cap table, and your company’s ability to share important details about your team during diligence. Each offer letter you send out creates important data points—the team member’s compensation, role, and equity promised. In addition, the protections included in your company’s confidentiality and intellectual property assignment agreements are essential to instill investor confidence in your ability to protect company assets.


The more your company grows, the more likely stakeholders will participate in the hiring process, including hiring managers for individual departments, finance managers, and equity compensation managers. When these stakeholders operate separately from one another—as they very often do—it makes all of the aforementioned data more difficult to wrangle.


This is where a standardized, unified hiring process may just well be your saving grace. It helps reduce the risk of errors and ensures that everyone from HR to legal to finance to the hiring teams are on the same page and accountable to the same expectations. More importantly, it means all those important documents will be in one place come due diligence time, and you won’t need to chase down important agreements on the eve of a fundraise.


Organize and secure all needed documents

In the beginning, your company won’t have a lot of documents, but that quickly changes as you grow, build your team, and develop your product. You’ll have great visibility into, and comfort in, your documents if you make a plan for managing them before things get out of hand.  


Develop a plan for where all your important documents should live. Consider an automated data room that syncs with your cap table to keep things organized. Make sure it’s organized by subject matter, ideally in a manner that aligns with the eventual request list that you’ll get from a potential investor, and that you can easily provide the appropriate level of access to that investor and their outside counsel when diligence begins. 


Check out our free Fundraising Due Diligence Checklist

For more information on the various documents and data sets you’ll need to have ready for your fundraising  process, download the free checklist. Our checklist enables founders to:


  • Get ahead of the requests that investors may make when kicking off a fundraise

  • Get a clear view of the must-have information and documents you'll need to collect and store in a diligence-ready fashion

  • Use the checklist alone or in partnership with an attorney or advisor to ready themselves for the fundraisng process 


How Fidelity’s equity management platform helps you prepare for due diligence


Preparing for due diligence can feel daunting—like the entire future of your startup is on the line. Luckily, this isn’t a process that you need to navigate on your own!


Fidelity’s all-in-one equity management platform is designed to simplify the due diligence preparation process for you, and set you up for success long before diligence begins, by automating all of your startup equity management operations and financings in a single collaborative hub. 


*****

By Lynne Zagami, Vice President of Customer Success, Private Markets at Fidelity


Fidelity provides cap table management and other administrative services to private company's equity compensation plans.

 

The statements and opinions expressed in this article are based on insights provided by the author and Fidelity. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney regarding your specific situation. 

 

Startup Boston is not affiliated with Fidelity. 


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