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Understanding Venture Capital: Due Diligence

Understanding Venture Capital: Due Diligence
12/18/2018 Coin Tasker
venture capital due diligence
3.7/5 - (3 votes)

Venture capitalists roll the dice when they put millions in a new business. That?s a lot of money to invest in something that isn?t guaranteed to deliver a return. But it?s important to remember that a lot of thought (and time) goes into a venture capital investment?in fact, the due diligence process starts even before the founder and investors meet face-to-face.

Every venture capitalist has their own unique process for due diligence, but no matter the firm, the goal is the same: vet the business and its founders as thoroughly as possible before shelling out the big bucks. Here?s a snapshot of what this process looks like, though it will vary slightly from VC to VC.

Before the first meeting

Networking coffees and events aside, startups can thank?venture capitalists inner due diligence controls for making it so challenging to snag an in-person meeting in the first place.

Large firms have entire teams dedicated entirely to sorting the obvious ?no-go?s, the potentials and the gems from the thousands of inquiries they receive annually. Most of the proposals that get ditched instantly are those that are not in line with the firm?s investment strategy. This is why it?s important to do your due diligence to ensure you?ll be a good fit.

If you?re lucky to be interesting enough that they want to take a second look at you, you?ll have at least one phone call with the venture capitalist, possibly two. Here, the firm is doing a few things: they?re making sure you meet their criteria. They?re also making sure you?re not crazy or totally unreliable, and that you can answer basic questions about your business, like target market, competitors and burn rate.

If, after this, venture capitalists?still find you interesting, congratulations. You?ve made it to an in-person meeting.

First meeting

At the first meeting, you?ll meet with one or two members of the firm. Plan for an hour. In this meeting, they?ll screen you to see if your business is what it appears to be, and if it?s hitting all their major must-haves. They?ll also keep their eyes peeled for obvious red flags, and want to get a good sense of who the founders are and why they?re the right people for the job. Key areas venture capitalists will want to discuss are:

  1. The opportunity: venture capitalists will want an idea of why your startup is a big deal. How big could it get? How big is the market? What are the areas of risk and adjacent markets, and who are the competitors in the space?
  2. The product and business model: What problem are you solving and how are you solving it? Why is your business new and exciting? How will your solution scale up? Are you using a common revenue model for startups or have you chosen a less common revenue model?
  3. The financials: How much money have you put into the business to date? How much debt do you have on the books? What do you think you need to take your company to the next level? They?ll want to see that you?ve thought these things through, but they also want to run the numbers on the backend to see what funds they?ll need for the next five to seven years to support you. Yes, even at this early stage, they?re already thinking follow-on rounds. It?s a long-term relationship!
  4. The team: Pedigree means a lot to venture capitalists. They?re going to want to get a feel for the founding team. Why are they the right people for this company? How does their past experience position them perfectly to build your startup into a rocket ship? How long have you worked together?
  5. The plan: How will you market your business? For example, you say you?re going to have a million users in two years, but how will you get there? What technologies do you use that make this scalable? Either at this stage or a later one, they may ask to see metrics around your pipeline.

Second meeting and on

If you make it to the second meeting, be prepared to have your startup examined under a microscope. At this point, it?s all about validation and verification. Venture capitalists will look to evaluate your claims in greater detail, and they?ll do a deep dive on your numbers and metrics.

  1. Thorough review: Venture capitalists will review everything you?ve got?users, usage numbers, frequency, customer churn, website traffic, you name it. Come prepared with everything, make sure it?s all up to date, and be ready to show them your methodology, especially around more slippery metrics like churn rates.
  2. Your roadmap: Can you explain where you see your product heading? What features are you planning and how do they address an established need? What are your options to pivot? How are you listening to customers for feedback? It doesn?t matter if you?re early and your future scenarios are based on educated guesses?Venture capitalists will want to see that you can think through these situations.
  3. Financial audits:?Where did you get your numbers and do they make sense? Are your accounts in order? Are you using the?best small business accounting software to maintain your accounts??Is your accounting function set up in a way that matches your business? How fast are you burning through cash?and, if the rate stays steady, how long until you need another infusion of capital?
  4. Technology: Do you have patents? Are there legal or technical risks associated with your product? What does it take to maintain and what are the resources you need as you grow?

Happening in the background

Outside the conference room, venture capitalists will continue to perform due diligence and gut checks. The goal: strip your business down and look at it from every angle. Got dirty laundry? Get ready to let it all hang out.

  1. Entity type: What kind of entity is your company? What kind of legal baggage are they buying into? Get ready to be uncomfortable here. venture capitalists will want to know if you?re dealing with lawsuits, angry ex-team members, HR issues. You get the idea.
  2. Technical audit:?Not all venture capitalists do this, but the ones that do will want to examine everything from your tech stack to your code.
  3. Shared connections: If you share any connections with venture capitalists, assume those connections are getting a phone call. VCs will want to hear about you from third parties?what you?re like to work with, how you think through problems, what your reputation is. VCs will also scour their contacts for industry experience to get ?inside intel? on your startup, and if it?s going to fly.
  4. Partner buy-in: You may have just met one or two venture capitalists, but these VCs need to get the buy-off from their entire team. They?ll share their due diligence findings among the partners, and, if you?re lucky, have you join a full-partner meeting. Consider this a vote of confidence?if your business warrants wrangling every partner?s schedule and getting them all together in the room with you, you?re almost certainly about to be offered a term sheet.


If you?re exhausted just thinking about this process, remember why venture capitalists do it: to protect themselves. When you?re investing millions of dollars of other people?s money, you can?t be too careful.

For startups that don?t want to deal with the six- to twelve-month process of raising capital from VCs, there are alternative options. VC is not the only way. Lighter Capital, for example, offers startups revenue based loans where startups can receive up to $1MM in as little as 4 weeks, and up to $3MM in follow-on rounds for companies that qualify.

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