One of the most common questions I get is what due diligence looks like for pre-seed companies. Here's a short summary of the key things I focus on for pre-product companies.
Great list Charles, captures a lot of the key areas especially founder equity, non-founders on the cap table and founder vesting.
I would add to the banking question, who is their lawyer? I've seen some great and not so great answers, including "my brother in law the divorce attorney".
I also like to vet the IP, especially ensuring that employees and contractors have assigned their IP to the company with a PIIA. Easy to overlook that one contractor you hired where you can't find their IP assignment paperwork. Sometimes founders themselves won't have signed them. And going down this path will often highlight any other relevant patent, license or royalty issues.
Good point, Todd. We typically get a peek into the law firm during the closing process, so we don't always ask that upfront. But we might going forward.
Agree with your list of categories. under founders section, I would also add investigating potential conflicts of interest on all key stakeholders. For example it is good to know of any of the decision makers are involved with other companies or have pecuniary interest in entities that the start up is paying for services. It is not necessarily a problem, but it provides a full picture of what might influence key decisions.
Thanks for sharing this Charles! We would love to chat with you if you have any interest in disrupting financial services, enabling companies to improve acquisition, engagement, and retention by matching their incentives with those of their customers and prospects!
I founded a company called DiligenceAfrica.co just to solve these issues around diligence for investors investing in Africa-focused opportunities. On the background checks, we also conduct offline background checks with local paramilitary agencies to ensure no negative reference checks comes up. We advise investors to work with local advisory firms before investing in a startup building for a market outside their immediate environment. Another diligence point I would add is find out where the technology of the company sits and who owns it. As an investor, I have seen situations where the tech was owned by the founders and they didn't think it was necessary to transfer it to the company. My guess was they intended to license the technology to the company.
In my opinion, I think the due diligence process is as important and crucial as the post investment process. What support structures do VCs provide to startups to enable them succeed? Building and implementing governance structures and processes at the early stages is critical to the long-term growth of the startup. Founders should be provided with the resources, tools and education to build sustainable, fund-returning businesses.
"In extreme cases, we work with founders to rebalance equity and correct things that we think will get in the way of future financings or otherwise feel unfair."
Charles, it would be good if you would share a hypothetical or example of ways you might do this.
Love this list. As an accelerator, we take 6% equity as do many others. What's your take on the ownership by venture studios, etc. that may own 30% or sometimes much more of the company? Have they de-risked the business enough to justify that?
Great list Charles, captures a lot of the key areas especially founder equity, non-founders on the cap table and founder vesting.
I would add to the banking question, who is their lawyer? I've seen some great and not so great answers, including "my brother in law the divorce attorney".
I also like to vet the IP, especially ensuring that employees and contractors have assigned their IP to the company with a PIIA. Easy to overlook that one contractor you hired where you can't find their IP assignment paperwork. Sometimes founders themselves won't have signed them. And going down this path will often highlight any other relevant patent, license or royalty issues.
Good point, Todd. We typically get a peek into the law firm during the closing process, so we don't always ask that upfront. But we might going forward.
Hi Charles,
Agree with your list of categories. under founders section, I would also add investigating potential conflicts of interest on all key stakeholders. For example it is good to know of any of the decision makers are involved with other companies or have pecuniary interest in entities that the start up is paying for services. It is not necessarily a problem, but it provides a full picture of what might influence key decisions.
Good point!
Thanks for sharing this Charles! We would love to chat with you if you have any interest in disrupting financial services, enabling companies to improve acquisition, engagement, and retention by matching their incentives with those of their customers and prospects!
Great content & insight. Thank you.
I founded a company called DiligenceAfrica.co just to solve these issues around diligence for investors investing in Africa-focused opportunities. On the background checks, we also conduct offline background checks with local paramilitary agencies to ensure no negative reference checks comes up. We advise investors to work with local advisory firms before investing in a startup building for a market outside their immediate environment. Another diligence point I would add is find out where the technology of the company sits and who owns it. As an investor, I have seen situations where the tech was owned by the founders and they didn't think it was necessary to transfer it to the company. My guess was they intended to license the technology to the company.
In my opinion, I think the due diligence process is as important and crucial as the post investment process. What support structures do VCs provide to startups to enable them succeed? Building and implementing governance structures and processes at the early stages is critical to the long-term growth of the startup. Founders should be provided with the resources, tools and education to build sustainable, fund-returning businesses.
"In extreme cases, we work with founders to rebalance equity and correct things that we think will get in the way of future financings or otherwise feel unfair."
Charles, it would be good if you would share a hypothetical or example of ways you might do this.
Love this list. As an accelerator, we take 6% equity as do many others. What's your take on the ownership by venture studios, etc. that may own 30% or sometimes much more of the company? Have they de-risked the business enough to justify that?
Great summary Charles - just curious do you commence with this work pre or post LOI / Term sheet? Suspect post LOI / term sheet but wanted to confirm.
Pre term sheet - it's an Airtable form that takes about 5 minutes to fill out.