Attracting funding is challenging and incredibly competitive for startups so the idea of being ‘picky’ about investors doesn’t always sit well with founders. However, for founders who are planning for the long-term success of their startups, it is incredibly important that you choose investors wisely. For those founders, we’ve outlined these 5 tips for startups doing due diligence on investors.
5 Tips for Startups Doing Due Diligence on Investors
Tip 1: Know What You Need From an Investor.
Determining and documenting what your company needs from its investors is a key first step for founders. This helps you set the stage for building out your non-negotiable terms for investors, as well as helping you firm up your list of questions for potential investors at the pitch stage.
Before drawing up a list of ‘ideal’ investors, you should know the following:
- What important expertise or connections are you currently lacking and do you need your investor to bridge those gaps?
- How involved do you want your investor to be?
- How often are you willing to report to your investors (and how detailed are you willing or prepared to make that reporting)?
- Do you want frequent or infrequent communications with your investor?
- Your non-negotiable terms (like Board seats and retaining control).
Knowing at least this about your investor profile enables you to filter out unsuitable investors at the earliest possible stage.
Tip 2: Consider Your Stance on ESG Issues – and Prioritize Knowing Your Investor’s Stance on Them, Too.
Environmental, societal and governance (ESG) issues are increasingly important for both companies and investors. For any startups tackling ESG issues (and publicly speaking out on them), it’s crucial that your choice in investor doesn’t undermine your efforts or your credibility.
For instance, if your startup is striving to tackle modern slavery issues, it may not be wise to choose an investor with a track record of investing in clothing companies with sub-par worker conditions. Firstly, this may be indicative of a culture of prioritizing reduced costs above all on the part of the investor. And, secondly, it may be difficult to justify that position to potential future investors or customers.
That being said, there are situations where the difference may present an opportunity. For example, companies in the oil and gas sector may be interested in investing in sustainability-focused startups (often to improve the company or industry image). In these circumstances, it is even more important that you are clear on the oversight the investor is hoping for before coming to an agreement.
Tip 3: Confirm Your Investor Can Deliver What You Need.
Investors do sometimes make startups promises of providing support, mentorship, and more, but fail to deliver. While your contracts are going to be the only way to guarantee the support you require (and there’s no guarantee investors will sign them), founders can perform a few checks to see whether it’s likely that support will be forthcoming, including:
- Discussing the support you require with any potential investor and asking for examples of how they will provide it.
- Confirming whether the investor has team members with relevant experience in the areas for which you require support.
- Review the investor’s social media presence to see whether they comment offering guidance or advice (indicating a culture of the provision of assistance beyond financial support).
At this point, it can be helpful to politely explain to your investor that you’d like to perform some measure of due diligence on them – to confirm that you’re the right fit for one another. Most reasonable investors won’t have any issue with this. If they do take issue with this, it may be a red flag indicating that your risk profiles and/or corporate values don’t align.
Tip 4: Speak With Founders Who Have Worked With Your Potential Investor.
Speaking with founders who have worked with your potential investor allows you to essentially perform a reference check on your potential investor. You should ask what it’s like working with the investor, including whether they delivered any additional support they promised and whether conflicts were well managed (if they arose).
Tip 5: Ask Other Investors (and Connections) About Your Potential Investor’s Reputation.
If your investor is legitimate and reputable, it’s likely that connections you have within your network and other investors are aware of them and have an opinion about them. You should ask around about your potential investor when performing due diligence on them to ensure that they are reputable (since scam investors do exist).
If you dig up information on them that you don’t find appealing, be sure to get all the details. For instance, if there seems to have been conflict in the past, work out whether it was associated with a particular team member (since they may have since left). Once you have as much information as possible to hand, you should speak with your co-founders or advisory team about whether it’s a dealbreaker for you.
If you’re a founder and you’re looking for assistance navigating the investment process, reach out. Our experienced attorneys have navigated startup investment from both sides, so we know how investors think and what they’re looking for. We’d love to use that knowledge to your advantage.
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