Venture capitalists are in the business of investing money in, generally, unproven startup companies. They invest money into startups that show great potential for growth.
VCs and their investors are able to make profits when equity they receive from their investment increases in value. However, the nature of the business is risky as evaluations of potential businesses can be faulty and can, ultimately, lead to losses.
This is why due diligence is imperative. Due diligence in the venture capitalist industry refers to the efforts directed at checking a potential investment opportunity. When done effectively it can identify the critical risks and the VCs are sometimes able to avoid problems deals. Here is how VCs can do better diligence to avoid the problem deals in the industry.
- Formulate due diligence binders: Due diligence binders come in handy if investment funds have been raised by outside investors. The coordination of these should be done by one person who is responsible for tracking and staying on top of information and updating documents regularly. Due diligence binders are testaments to your levels of preparation and they serve to hasten the review process.
- Ensure effective communications: During due diligence interactions, investors are looking to evaluate the content of your response to their questions. In most cases your response to their requests are assessments of your level of preparation and your capability. To ensure that you satisfy prospective investors, it is important that there is effective communication. To achieve this, it is best to designate one person to coordinate the responses to their request. Doing this makes it easy to keep the responses consistent which gives the impression of professionalism and capability. It is also important that the questions are answered in full and that the responses given to investors requests are complete. Effective communication also lets a VC know when a deal in no longer feasible and should be avoided.
- Improve Your Due Diligence Processes: VCs can improve their due diligence processes by leveraging on the feedback gotten in subsequent processes. Lessons learned can be applied in the next due diligence process so that possible problem deals can be easily identified and avoided. Improved due diligence processes also ensure that adequate trust is built and maintained. This is a key aspect of any investment deal. All the parties involved should be assured of each other’s capabilities and that they will honor their end of the agreement. Having a great diligence process can provide a clear view of the deal and serves to lay the foundation for possible partnerships.
A due diligence process is the difference between the issuance of a term sheet and signing up for a problem deal. Apply the guidelines described here to avoid the risks of problem deals that are part of the investment business.