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Getting your ducks in a row: due diligence for start-ups and scale-ups

For start-ups and scale-ups looking for venture capital funding, due diligence is an integral part of the fundraising process. Lucy Graham from our Technology team looks at this process in more detail and what you need to consider when carrying out due diligence for your business.

Now is the time to strike while the iron is hot

During 2020 private equity firms across the globe built up record sums of unused capital or ‘dry powder’, with a massive $2.9 tn uncalled capital at the end of the year. Of this total, the proportion of uncalled capital waiting for venture capital investments had grown by 244% since 2010[1].

This resulted in a strong start to 2021 for the technology sector, with an increase in reported venture financing deals – from 4,045 deals recorded in Q4 2020 to 4,818 deals completed during Q1 2021[2] representing an increase of over 19%.

The outlook for business in the UK is also peaking, with the FTSE 100 increasing by 17% on the year to April 2021. The Institute of Chartered Accountants in England and Wales’ Business Confidence Monitor recorded the highest levels of optimism since their survey began in 2004, meaning that a large majority of companies expect economic conditions to improve over the next 12 months compared to the previous 12.

These factors combined mean that now is a great time for start-ups and scale-ups to find venture capital funding, and due diligence forms an integral part of the fundraising process.

Due diligence sounds scary, but it isn’t

Wikipedia defines due diligence as: “The investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care”.

The due diligence process usually begins after your pitch once the broad plans for the investment are agreed via a term sheet. Venture capital firms will each have their own processes and requirements to confirm the viability (or otherwise) of the proposed investment, but there are steps you can take to ensure the process runs as smoothly as possible.

Be aware that both sides can benefit from due diligence – you as the founders and business owners are already the biggest investors in the business in terms of both cash and time/effort, and identifying any risks or areas that need work at a pre-funding stage can be extremely valuable and by addressing these in advance could even lead to an improved valuation.

Getting to know each other is key

Preparation is key when considering raising funds for your start-up.

Due diligence is an important part of this process. It allows both sides to consider whether they have a future together, and what that relationship might look like.

Investors are looking at the business as well as the individuals or team behind it and will be interested in your history as well as your future, so if there are any skeletons in your closet now is the time to reveal them.

You might want to track down founders of other portfolio companies the fund has invested in to gather their feedback both on how the due diligence process worked as well as what their relationship with the investors looks like post-investment. This information will form part of your decision-making process when ultimately you have to decide if this investment is going to be the right fit for you and your business moving forward. By failing to prepare you are preparing to fail.”

Preparation is key when considering raising funds for your start-up.

You can be prepared by having information collated and ready to share, covering your finances and business to date as well as detailed plans and projections. Also consider whether you have given enough thought to some of the less glamorous aspects of running your business.

Potential stumbling blocks which could scupper your investment progress include:

  • Legal contracts with customers and suppliers
  • licences and regulations
  • compliance with General Data Protection Regulation
  • robust employment contracts and
  • payrolls and IP licences and registrations

so make sure you get the documentation and procedures in place as soon as you can. As long as you have presented both yourself and your business honestly during the investment pitch, due diligence does not need to be a stressful process, instead it can become one of the most rewarding and enlightening periods of your company’s journey to date.

How we can help

Blick Rothenberg’s Technology team has extensive experience in supporting our clients through the due fundraising diligence process.

We can provide support at all stages of your fundraising journey; from the very start, providing advice covering how to structure your company to secure access to tax reliefs for your investors via the Seed Enterprise Investment Scheme and Enterprise Investment Scheme, while also providing you as founders with the best structure for your own long-term goals.

We are also able to assist with preparing your business plan and forecasts, and ensuring you are compliant with all ongoing tax and reporting requirements.

We will support you through the due diligence process itself, liaising with your own legal advisers as well as those of your potential investors, providing them with timely and accurate responses to their enquiries to ensure a smooth due diligence process and a positive outcome for you.

Please contact a member of our technology team, your usual Blick Rothenberg contact, or Lucy Graham, using the details on this page, if you would like to discuss this further.

[1] Preqin, Bain & Company Global Private Equity Report 2021

[2] GlobalData Deals Database