Here is a truth that is often not spoken enough, investment deals get called off because the startup failed due diligence.
Here is a typical fundraising round:
1. You pitch to as many relevant investors as you can.
2. You get into second or third calls with some.
3. One (or few if you are lucky) sends you an offer sheet. If you accept...
4. The investor sends a team to perform due diligence on your company. They will go through all of your paperwork, including share register, customer contracts, supplier contracts, employment contracts, accounts and so on. The due diligence can be tougher than a financial audit.
5. If all is well, you get a term sheet.
6. Once that is done, a shareholder agreement is drafted, negotiated and signed.
When you hear in the news a startup is funded, that is after Step 6. Many founders couldn't get past Step 1 and Step 2. That is fine - usually due to lack of fit. However, you will never forgive yourself if you fail due diligence.
What are the kind of due diligence that throws investors off?
1. No paperwork at all. If you can't be bothered to maintain documentation, how can I trust you with money?
2. Lots of inconsistencies or gaps in paperwork. Similarly, if you can't be bothered to keep things proper, how can I trust you to use the investor money properly?
3. Loads of debt. No investor invest in companies just to pay off debt or obligations that has nothing to do with growing the company. This is also the reason why "commissions" to arrange investors will not work with reputable investors.
I have been a startup mentor for 5 years at MaGIC now, and the most common problem I see is that founders avoid paperwork like its a disease. Founders who do not have the business plan documented is far more common than you think. All those years founders that ignore paperwork and accounts in pursuit of business growth will find the bite back hard. Just this week I was informed of few startups that failed their due diligence. The investor has called off the intended investment. These startups are likely to be liquidated, unless they can accept to be acquired.
Paperwork is necessary. It is the only acceptable evidence in the contract world. Not having an in-house lawyer or a lack of business administration knowledge is no excuse for not preparing customer contracts, employment contracts, business plans, marketing plans, business strategy, financial projections, monthly business performance reports and so on.
If you find that you don't have the knowledge on what to do, you can get a mentor and join private entrepreneur groups. If you don't have time to do, consider hiring a business administrator. If you don't have time and spare money to train, outsource these to an experienced business administrator consultant. If you are lucky, some may do it for equity. The worst heartache any founder can get is to have an investor interested but they get rejected because they failed the due diligence.
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