Due diligence is an essential part of fundraising that allows potential investors to evaluate a startup's viability and financial health. The process will look at everything about your startup - your financial statements, compliance, market position, management team, and more - to determine whether or not they will make an investment in your company.
Throughout the due diligence process, you have the opportunity to build - or erode - trust in your team and confidence in your startup’s viability as an investment. Therefore, preparedness for due diligence should be well thought out before pitching to investors.
Getting Started with Due Diligence
Due diligence isn’t a one-size-fits-all process, each startup may face unique investor requests. However, most due diligence efforts center on five key areas: commercial, operational, financial, legal, and organizational.
In particular, financial due diligence involves analyzing your startup’s profitability, unit economics, cash burn, and overall value. Having up-to-date models and financial statements ensures everyone is working from the same set of facts, building trust and saving time during investor conversations. For more guidance on aligning your internal processes with investor expectations, check out Tips for Successful Startup Fundraising.
Preparing for a Successful Due Diligence Process
To make this process more efficient, early-stage startups should prepare a well-organized virtual data room that covers all key due diligence areas. Doing so signals professionalism and helps investors evaluate your business more quickly and confidently.
What Goes in the Data Room?
Start with these core items:
- Cap table - helps investors assess ownership, dilution risk, and potential future rounds.
- Pitch deck - provides a high-level overview of your business model and vision.
- Financial statements - show revenue, expenses, cash flow, and balance sheet position
- Market analysis - Shows how well you understand your market, customers, and competitive positioning.
- Legal contracts -Identify obligations and rights with customers, employees, and partners
- Corporate governance documents - show legal structure and decision-making history. (e.g. Articles of incorporation, board minutes, and bylaws)
- Tax Returns - Usually the last 3 years of tax returns for both federal and state.
Maintaining this data room, not just building it once, is key. Keep documents current as your startup evolves, and track version histories to show progress.
For a more detailed breakdown of what to prepare, please download our Due Diligence Checklist.
Review and Address Gaps
Once documents are uploaded, thoroughly review them to identify gaps or areas needing improvement. Proactively addressing potential concerns can strengthen your position, as investors value startups that demonstrate foresight and transparency.
Communicate Openly
If there are unresolved gaps from point #2 or if the investors have general questions, be timely, accurate, transparent, and most of all, consistent with your responses. Remember, this is not only an analytical exercise but also an opportunity to build credibility with investors. Accuracy and consistency as you respond to investor requests are critical to continuing to build a trust-based working relationship.
Common Misconceptions in the Due Diligence Process
“Investors Will Use My Financial Model as the Sole Basis of Their Decision"
The model provides an initial sense of the startup’s financial health and growth potential, but due diligence encompasses much more than projections. Recall that the assessment goes beyond numbers - investors will examine both quantitative and qualitative aspects of the business. True, investors will scrutinize your financial statements, compliance practices, and market position, but they will also be evaluating the management team's vision, technical expertise, business acumen, and cohesion (Source: wallstreetprep.com)
"409A Valuations Determine How Investors Perceive My Startup’s Value"
A key point to know is that a 409A is not an investor valuation. Rather, the 409A is a third-party assessment named after Section 409A of the Internal Revenue Code and is used primarily for tax compliance and internal equity allocations. Investors will conduct their own valuations.
"My Pitch Deck Needs to Be Visually Stunning"
While a polished pitch deck can help make a great first impression, investors prioritize the content over aesthetics. Your slides should at a minimum be legible, simple, and obvious - leave no room for the investors to guess at the points you’re making.
For more information on how to optimize your pitch deck for early-stage investors, we recommend checking out Y Combinator's article "How to Design a Better Pitch Deck"
Work with our team at Founder’s CPA
A blog post can only scratch the surface of what will be required, as due diligence needs will vary from investor to investor. While navigating the process can be daunting, it’s also important to remember that this is an opportunity to showcase your company, product, and vision. If you are getting ready for a fundraising round, but don’t have the resources for a full-time CFO, consider partnering with Founder’s CPA and leveraging our Fractional CFO Services to help position your company for a successful fundraise.
Contact us today for more information!
