Why Is Due Diligence Important?

What Is Due Diligence in Start-ups?

Due diligence is often discussed, yet rarely fully appreciated until entrepreneurs are right in its midst. Right when they are feeling the pain of learning it the hard way.

Fundraising

The most common form of this will arise at each attempted round of start-up fundraising or in the case of the Start-Up Visa application, when applying to the Designated Entity. This is the most intensive and thorough part of the process. There may be similar types of underwriting and investigation done when applying for various other types of financing.

It Will Make or Break Your Company

Due diligence is the key to being accepted by the Designated Entity and IRCC, raising capital, merging companies, making strategic acquisitions, and finally exiting or taking your company public. You won’t be able to do any of these things without getting through due diligence.

Revealing Your Secret Sauce

While this should certainly be a secondary concern to getting the funding or acceptance you need for growing your company, unscrupulous entities and bad actors will use this process to learn the ins and outs of your business and then use it for their interests.

Disrupting Versus Uniting Your Team

The due diligence experience can substantially impact your team for better or for worse.

It Can Make or Break You

This will be one of the hardest things you’ve ever experienced up until this point. Even more so than taking the leap of faith to try and bootstrap a new business idea or to go pitch hundreds of investors despite receiving just as many noes.

Why Is Due Diligence So Important For Designated Entities, IRCC, and Investors?

Understanding What They Are Investing In

You might have an outstanding sales pitch that gets them excited and eager to throw down an appetizing term sheet, but then they need to get to grips with the reality of what they are investing in.

The Value

This is a financial transaction for investors. This means that they both need to look at a realistic economic forecast based upon some tangible proof of concept or sales data and the actual value of assets, like intellectual property, or hard assets like real estate.

The Risks

What liabilities and risks are their investments going to be exposed to? It could be operation, legal, market forces, or other risks. When balancing their overall portfolio and potential for average returns across their invested start-ups, they need to calculate that.

Legal & Financial Responsibility

Investors typically also have legal and financial responsibilities to others, too. VC firms and start-up accelerators will have LP investors whom they are responsible for. They have to repay them. If things go wrong, they can be sued if they didn’t conduct a reasonable amount of due diligence on the investment.

What Due Diligence Is Involved?

Among the many parts of this process, you can expect the following.

Vetting The Founders

Founders and other key players can make or break a company and investment. This is not only about their abilities but also about scruples and integrity. Even Mark Cuban has had to step in and take over start-ups due to rogue founders.

Reviewing the Organizational & Financial Structure

The quality of the founding team is essential. More so about, who the other executives, key team members, and investors and owners are.

Interviewing Customers

They will want to interview your actual customers. They will want to know how happy they are and how likely they will stay as paying customers. They want to make sure the product does what you claim. Or, if you are pre-revenue, they will want to see LOIs of companies willing to engage your product when it is launched.

Verifying IP

Investors and acquirers must verify patents, trademarks, and other intellectual property. They will also want to know that you have filed and owned it and how much it may be worth.

Verifying Financial Statements & Forecasts

Expect them to go through every dollar and document. They will likely also create their forecasts and potential outcomes. Often, these may be even more bullish than yours. However, poor accounting can undoubtedly detract from your valuation.

Valuation

Investors and buyers may use various methods and approaches to value your business. This will depend on their preferences, the stage of business, what they intend to do with it, how they will fund it, and how the transaction is structured.

Legal Issues

Careful attention needs to be applied to pending lawsuits, litigation, or settlements.

Risks & Assets

They will need to review customer contracts, retention versus churn rates, and employee contracts, as well as evaluate the value of individual assets and their liabilities.

How to Ace Due Diligence

How can you improve the due diligence process to preserve and add value, keep these parties motivated, and make it go faster and less painfully?

Be Transparent

Your pitch and deck are sales tools. Be honest upfront in your pitch, and it won’t fall apart in due diligence.

Have Your Team United

Before entering any of these processes, your whole team should be united on the goal. This includes your workers, cofounders, shareholders, and board members.

Be Organized & Keep Clean Records

Please don’t wait until it’s due diligence time to try and pull everything together and catch up on your taxes or other accounting and paperwork. Take the time to create systems and processes in advance. Prepare a data room for your due diligence in advance of pitching.

Be Prepared Mentally & Financially

Be prepared for how long this will take, how hard it will be, the extra labor, meetings, hours, and stress. Brace yourself for the emotional roller coaster, negotiation tactics, renegotiation, and plan for the costs to your business for all of this.

Summary

Due diligence is highly pivotal for start-ups. One of the most influential parts of building a business is fundraising through your exit.

Do you require more help with your Canada startup visa or immigration needs?

If you’re interested in other pathways for immigration to Canada, we’ve also prepared an article to help you learn about how to immigrate to Canada with a work visa. And if you want to learn how to start your own business in Canada, we have just the right article for you!

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