You made it past one of the more nerve-wracking experiences anyone will ever endure in a lifetime - the business pitch to potential investors. You did it. They're interested.
You're ecstatic, on top of the world. And, dare I say it? Feeling invincible.
It's common. Though founders recognize the importance of background research as a vital business strategy, and are certainly used to scrutiny, the thought of every element of their business going under the microscope, is enough to make anyone uneasy.
There's no reason to fear the lens though, especially since you already did the work to validate your concept, right?
If you're an active part of the due diligence process, it won't feel like a top secret government background check. It will be more of a collaborative process that limits surprises and removes skepticism from the room for both sides.
It starts at the pitch
Technically, due diligence begins in earnest after the initial meeting with investors. But you better believe VCs are watching your team closely during the pitch. Consider it their qualitative research.
They're looking at how your team interacts with one another. How well you understand and own up to your own shortcomings. Whether or not you'll be easy to do business with, how you operate under pressure, and so on.
There will be plenty of time for quantitative analysis of your go-to-market strategy, financial projections and your distribution channels - and it will be thorough.
Anticipate multiple meetings
You've passed the initial qualitative assessment, now the quantitative analysis begins. Be prepared for more phone calls and impromptu sit-downs. At this point a potential investor is pouring over your go-to-market strategy, financial projects, distribution channels, etc.
Anything founders say during the pitch is open to further scrutiny, but that doesn't mean investors are looking for a "gotcha" moment.
"The diligence process is about uncovering skeletons, with the expectation of not finding any," said Nathan Mortensen, principal at Tallwave Capital. "It should be about validation and verification of what you've told investors."
The first point of research is on the market as you've presented it. How might your product disrupt the marketplace? How concentrated is it?
VCs might test your sales and marketing strategy by re-pitching your idea to other investors and their peers to determine just how attractive the idea is. If they're still interested, that means the diligence they've performed on your idea, and on you (through references and friends in the industry), checks out.
Make a VC's due diligence your top priority
To help make the process collaborative and to leave a good impression with your potential investors, always be at the ready for any requests. How well you organize, prepare and communicate as a team is under as much evaluation as anything else, and your attitude under stressful situations tells VCs all they need to know.
It's almost a guarantee that investors will find holes in some aspect of your business. That doesn't mean you've failed.
Make sure you've anticipated all the possible inquiries you might get, but also don't be afraid to ask investors for their suggestions on how to fix problems. VCs will be more inclined to follow-up further to see how proactive you are and how well you can implement their idea.
Don't attempt to fake it until you make it
Most investors have been in the game for a while, and as such, you can bank on tough questions. Whether you know all the answers or not, or you have a few less-than-favorable responses, own it.
"Know your numbers and tell the truth," said Mortensen. "We will find out the truth anyway, so don't gloss over bad numbers or make up good ones. Address it head on to show that you own the situation and take responsibility."
If you face a question you didn't anticipate, it's okay to ask for time to respond. VC's want to know how you think and respond, especially in uncomfortable situations.
As meetings progress and more investor assumptions are verified, the line of questioning shifts to scale. Do you as a founder have a good idea of where your company is going? What do your expenditures and revenues look like down the line? How do you anticipate the market changing?
Investors want to know how much funding will be required throughout the investment relationship, so again, don't make it up.
Entrepreneurs should welcome VC due diligence. You've worked hard to make your product deal-worthy, and it's your time to let your self-belief pay off. Every step you advance in the process is a sign that you're doing things the right way.