Preparing for Investor Due Diligence
By Tom McCollum, ACA · Former KPMG Corporate Finance · Compass & Ledger
The short answer
A term sheet isn't a closed round. Due diligence is where deals slow down, reprice or fall away, usually because information is missing, inconsistent or slow to arrive. Build the data room before you need it, reconcile your numbers across every document, and fix the legal issues investors routinely find: IP assignment, option grants, 83(b) elections and cap table errors.
Due diligence tests whether what you told investors is true, and whether anything could hurt their investment later. Most issues found aren't deal-breakers. What damages deals is surprises: problems investors find themselves, late in the process, that you should have raised first.
What investors check
Financial
- Historic accounts, monthly, and how they reconcile to the model and the deck.
- Revenue quality: recurring versus one-off, how it's recognised, and any large or unusual contracts.
- Customer concentration. A single customer making up a large share of revenue will be examined closely.
- Burn, cash and the assumptions behind runway.
Commercial
- Customer contracts, churn and cohort data.
- Pipeline claims made in the pitch.
- Often calls with a handful of customers.
Legal and corporate
- Company formation documents, board minutes and stock issuances.
- The cap table, reconciled to the legal records.
- Material contracts, including any change-of-control terms.
- Employment agreements and contractor terms.
IP and technology
- IP assignment from everyone who built the product.
- Open-source licence use and any third-party code.
Tax and compliance
- Federal and state filings, payroll taxes and sales tax registrations.
- Any regulatory licences your sector requires.
The issues that delay US deals most
These come up repeatedly. Each is fixable, but some take weeks.
- Missing IP assignments. A founder or early contractor who never signed an assignment may technically own part of the code.
- Options without a 409A valuation. Grants made without a current 409A can create tax problems for employees and need correcting.
- Missed 83(b) elections. Founders with vesting stock who didn't file within 30 days face a tax issue that's hard to fix after the event.
- Cap table errors. SAFEs or option grants recorded incorrectly, or issuances without board approval.
- Sales tax exposure. Selling into several states without registering can create liabilities investors will want resolved.
- Numbers that change. Revenue or margin that moves between the deck, the model and the accounts invites a much deeper review.
Build the data room before you need it
A complete, well-organised data room shortens due diligence and signals a well-run company. A suggested structure:
- 1.Corporate: formation documents, bylaws, board minutes, cap table and stock ledger.
- 2.Financial: monthly accounts, the model, budget versus actual, tax returns, bank statements.
- 3.Commercial: top customer contracts, pipeline, cohort and churn data.
- 4.Legal: material contracts, leases, any litigation.
- 5.Team: org chart, employment and contractor agreements, option grants.
- 6.IP and technology: assignments, patents or trademarks, open-source policy.
Keep it current, name files clearly, and make sure every figure in it matches the deck and model.
How to handle the process
- Assign one person to own requests and track them in a single list.
- Answer in writing, and keep answers consistent with what's already been said.
- Raise known issues yourself, early, with the fix. It builds trust; investors finding them builds doubt.
- Don't let due diligence stop you running the business. Investors watch whether performance holds up during the process.
How long does it take?
With a ready data room and clean numbers, seed due diligence can take a couple of weeks. Series A and later typically take longer and go deeper, sometimes including a quality-of-earnings review. The biggest variable is how quickly you can answer questions.
Frequently asked questions
What is a data room?
A secure online folder where investors review your company's documents during due diligence.
When should I build it?
Before your first investor meeting. Building it after the term sheet adds weeks at the worst moment.
What happens if due diligence finds a problem?
Most issues are fixed before closing or reflected in the terms. Problems you disclose early are far less damaging than ones investors find.
Get diligence-ready
We build data rooms, reconcile the numbers and prepare written answers before investors ask, as part of Investor Ready in 30 Days.
Thirty minutes. No pitch. Your situation, and what we would do about it.
If we are a fit, we will say so. If we are not, you will hear that too, and where to look instead. Either way you leave with a clearer picture of what good finance looks like for your business.