What should a series A funding process look like? Step 5: due diligence and transfer of money to the bank
Please read series A funding plan and strategy, the first step of the process - the introduction to an investor, the 2nd step - first meeting and follow up, step 3 - present to the partnership, step 4 – Negotiations and Legal Discussion and now the final step: the due diligence and money transfer.After the investor offers your a term sheet, they will mention that the final money transfer is subject to clearing their “due diligence”. Anecdotal evidence from 4 people in my VC network suggests nearly 10%-15% of companies which get a term sheet do not clear the due diligence. That’s a very high number.
What is a due diligence?
Its examination of the facts stated by you to ascertain if they were true.
The due diligence checklist (sample: pdf file), typically consists of anywhere from 10-15 (short) list of items to 10-20 pages of items. The items include your incorporation paperwork, tax and regulatory compliance, IP rights ascertainment, contracts signed, customer verification, and a host of other items.
Everything you mentioned in your presentations before (including customers you signed, revenue you currently are booking, etc.) will have to be verified.
Typically if you are a small startup doing little revenue, this might take 2-3 weeks, but if you are a larger entity it might take a month or more. Usually it is done in parallel with the term sheet negotiation, and will take up (in India) 1/2 time for that period of any individual. It consists of bringing together multiple documents and paperwork that you may have missed, filed or recorded.
This is one of the main reasons why fund raising becomes a full time job for one of the cofounders. I would also recommend you giving a heads-up to your Chartered Accountant or your lawyer so they can help you with these, but realize you (or someone you assign) will have to project manage this entire task.
Most investors (both in the US and India) prefer to transfer money in full to your account once the paperwork has been signed. Sometimes as part of the negotiation, you might get specific milestones that you might have to hit for more money to come to your bank. That’s typically called investing in installments or “tranche“.
Within 1-2 weeks of your final negotiation, you will be expected to put a “90 day” and a full year financial model and plan. You will be expected to hit these metrics (preferably go above and beyond). You should also expect a monthly (at the minimum) review of the key metrics (revenue, customers, hiring, etc.).
What might go wrong and how to fix it?
1. Your are missing certain items in your due diligence list. The key is to warn early. Tell your investors you are either missing or have lost or dont have a few items. You will be given time to get those fixed or in some cases they might waive it – it depends on the nature of that item.
2. There are some discrepancies between what you mentioned during your initial presentations and the documents you submit. That happens more often that most investors like and is probably the cause of most of the term sheets being rescinded. My personal suggestion is to be totally transparent and upfront with your investors before the due diligence so you can avoid this situation.
3. Some of the items in the due diligence dont apply to you, or they dont make sense or you dont like to share them. If they dont apply, ignore them and communicate. If they dont make sense, learn. You dont have a choice but to share everything with the investor.