What Is Involved in the Due Diligence Process for Venture Capital Financing?

Before investing in a company, a venture capital firm goes through a stringent review process to ensure that there are no skeletons in your corporate closet and that the perceived business opportunities are in fact real. The due diligence process generally focuses on two aspects: business diligence and legal diligence.

The business due diligence process accomplishes several objectives. First of all, it is important for the venture capital firm to independently confirm your assertions about your company's product or service and the market itself. Thorough competitive and financial analyses will help investors gauge the risks they will be assuming and the potential return on their investment. If your business plan hinges on technology, the venture firm will also need to assess your technology to make sure that there are no flaws in or infringements on patents, for instance.

If you are seeking later-stage funding, the venture firm will also contact key customers and suppliers to do reference checks. Industry experts may also be called on to discuss your company's potential.

In addition, because the success of your company hinges on a strong management team, it is important for investors to gain a complete sense of the company and the key players. Background checks are not unusual and your culture, management approach, and decision-making and problem-solving skills will be judged.

Legal due diligence is performed to ensure that all legal matters have been correctly and completely addressed. The firm's lawyers will request a comprehensive list of documents. See the sample due diligence checklists at AllBusiness.com. Because this is standard operating procedure, make sure that all your legal documents are in order and you are prepared for their requests.

The checklist of requested documents will typically include the following:

Key contracts

Employment agreements

Minutes and consents of the board of directors and shareholders

Confidentiality and invention assignment agreements with employees

Corporate charter and bylaws

Litigation-related documents

Patents, copyrights, and other intellectual property-related documents.

Past financing agreements and shareholder agreements

The due diligence process can be time consuming. It will involve multiple meetings and interviews with management, at both the investor's and your offices. Make sure you anticipate questions and requests particular to your business and you are well-prepared and have all the necessary documents organized.