How to prepare for due diligence: Checklist for startup founders

Before putting their money into a company, venture capitalists (VCs) do a detailed analysis called due diligence. It involves verifying finances, evaluating the team, analyzing the market, assessing the business model, and other factors that determine the potential of the deal.

Here’s what VCs usually want to find out before making an investment.

#1. Founders’ background

Early-stage startups don’t usually have outstanding metrics that can help investors assess their potential. For this reason, 47% of VCs say the company’s team is the most important factor when making a decision to invest in it.

Due diligence at this stage starts with VCs checking the founders’ backgrounds. They make reference calls and talk to as many people as possible, including founders’ former colleagues, customers, and investors.

Here’s what we need to know:

Personal traits of the founders. Are these people diligent, resilient, curious, and optimistic?

Founders’ professional background. How well does the founders’ previous experience match the chosen market?

Results founders achieved previously. What have they accomplished throughout their careers? Did they excel in sales, recruit a strong team, or help their previous employers enter new markets? If a founder previously failed with a startup, they should mention it — what lessons have they learned?

Relationship between the founders. Do the co-founders know each other well? What have they achieved together?

Founders’ early hires. Whom did they hire first? Do these individuals have the qualities and experience that complement each other’s expertise?

In this process, it’s crucial to let investors get to know you. Begin with your pitch deck, where you can talk about your team’s experience, past projects, and the results that make you proud.

Read more: Here’s how to make a 5-slide pitch deck

#2. Market, competition

Investors check out the market the startup is getting into — it needs to have room for a new player and be big enough for the startup to have a shot at becoming a big company worth millions.

We always do extra research on the market. If we find out that there are already a couple of big players who own most of the market, that’s not a good sign. It means it’ll be tough for a new startup to break through with its product.

Here’s what we need to know:

Market size. What proof is there that the market is growing and has lots of potential?

Standout factor. How is this startup different from the competition and how will it outperform them?

Target location. Is the market this startup is aiming for big enough? How many countries are in the picture? Is the startup aiming high enough in terms of market size? What’s the plan for expanding?

#3. Product or service 

When we check out startups, we try to figure out if they can make it big. We pay attention to things like how good the product is, if it fits the market, and how likely it is to succeed. To figure all this out, we ask startups for specific data.

Here’s what we need to know:

Value proposition. What problem does your product or service solve? Tell us step by step how it works. Show us some numbers too, like how many people have this problem and how your product makes their lives easier.

User stats and info. We check out things like how much people use the product, how long they stick around, and other numbers to see how much it can grow.

Customer feedback and stories. It’s important to try the product on your target audience first. If we see happy customers and good stories about the product, it tells us that people like it. If there are any issues, let us know how you plan to fix them.

Development stage. What stage is the product at right now? What important things has it accomplished or aims to do? Give us a timeline for these goals. Are there any risks or problems that could slow down the development in the future?

#4. Financial traction

Investors check the numbers to see how a company can grow in the future, how effective the team is, and if the product is in demand.

Here’s what we need to know:

The latest numbers. What are your most recent numbers that show progress and growth? How fast is the company growing? How much money is spent on getting new customers? What’s your LTV (customer lifetime value), CAC (customer acquisition cost), retention rate, and revenue?

The metrics a startup should show depend on the industry it’s in and what it focuses on. If you have a software startup, investors will ask about annual recurring revenue, bookings, and churn rate. For an EdTech startup, they’ll want to know about user acquisition and engagement stats, revenue-related indicators, and customer retention.

#5. Business model

As a founder, you need to demonstrate how you’ll make money by solving the problem and how much revenue you can generate from each customer. Show investors how you handle expenses and work towards making a profit or expanding.

Here’s what we need to know:

Pricing strategy. How are you planning to make money? Will it be through selling directly, subscriptions, ads, or licensing?

Distribution channels. How are you getting your product out there, and why did you choose that method? Which areas are you targeting?

Go-to-market strategy. How are you going to introduce your product or service to the market and get people to use it?

Expected revenue growth. When will your revenues start to increase?

#6. Legal issues

During the legal check-up, investors dig into your captable, deals with other investors, permits, and other paperwork. The more info VCs have, the better they can evaluate and handle any legal risks connected to the investment.

Here’s what you need to know:

Intellectual property rights. Are your intellectual property rights protected well enough? Does your startup rely on licenses from others? Do you have any patents? How easy would it be for competitors to copy your technology?

Company structure and rules. How is your company organized? Who owns what? And how does decision-making happen, like who’s on the board and how votes are taken?

Legal and regulatory compliance. Do you have the right permits to operate in your market? Can you prove that you pay your taxes? How do you protect customer data and keep the workplace safe?

#7. Exit opportunities

When VCs consider an investment, they are keen to understand the potential avenues for future returns. That’s why they try to understand the potential exit strategies available to a specific startup in the future.

Here’s what we need to know:

Other exits in the market. Which companies in this industry recently cashed out? How did they do it? Knowing about successful exits gives you insights into what might work for your own startup.

Exit plan and vision. What’s your startup’s plan to exit? Who might buy your company in the future? Having a clear exit plan shows investors that you’ve thought things through and have a solid roadmap.

Timing and preparedness. When do you think you can exit? Are you ready for it? Being honest about your timeline and readiness helps investors see if their investment goals match your startup’s plans.