Most investors will carry out a degree of due diligence before they commit to investing in your business. This blog explains what due diligence is and how you can prepare.

What is due diligence?

Due diligence is a process during which potential investors find out information about your company to decide whether they wish to proceed with an investment.  It usually involves investors asking you a series of questions about different aspects of your business, typically in the form of a questionnaire. The level and scope of due diligence will depend on the type of investor, the nature of your business and the structure of the proposed investment but broadly, due diligence can be broken down into the following areas:

• Legal due diligence – matters such as corporate structure, contracts, assets, intellectual property, insurance, compliance, employees and any leases or other property;

• Financial due diligence – the current financial status of the company, any accounts, any past performance of the company, financial projections and any debtors or creditors;

• Technical matters – where a product or service includes a highly technical aspect, the investor may or may not appoint an independent assessment of the product or service;

• Commercial due diligence – market share, commercial processes, competitors, commercial viability and customer base. 

Why do investors carry out due diligence?

The burden is on an investor to find out everything they want to know about a business before investing in it. There is no duty on the company or its owners to voluntarily offer up information, although in our view it is always better to be transparent.

There is always a risk for investors that a business will not be successful and they lose their money. This is particularly the case in an equity investment scenario where an investor purchases shares in the hope that they will receive some income and eventually make a profit when the company is sold or listed on a stock exchange.  If the company fails and is wound up, the shareholders will be the last category of people to receive any money back.  By asking for information about the company upfront, an investor will be able to weigh up any risks and make an informed decision about the terms of their investment. 

How can I prepare for due diligence?

If investors are showing interest, you do not want to lose momentum, so being prepared for due diligence is key. Here are some tips:

• Collate and sort your business documentation into categories: e.g contracts, accounts, insurance etc and try to anticipate questions investors might ask;
• Identify any missing documents or problem areas in advance;
• Ensure copies are stored electronically so that they can be easily reproduced;
• Avoid mixing documents, i.e. store each document as a separate PDF;
• Ideally, documentation would be stored in date order with a covering index;
• Obtain any missing documentation or necessary professional input in advance e.g accountants.

Where can I store my business documentation and data?

Any storage that you use should be sufficiently secure to preserve confidentiality.  You could use a file hosting site such as Onedrive or Dropbox. Alternatively, you could look into using a more sophisticated platform such as an online data room. 

How can I protect the business information that I share with potential investors?

We would always recommend ensuring that you have a confidentiality agreement in place with potential investors (also known as a non-disclosure agreement or NDA) before you share any confidential information with them. This can be a standalone document or it is sometimes contained in Heads of Terms.  Either way, you must ensure that confidentiality provisions are drafted correctly so that they are legally binding and the parties are clear on what information is restricted.