When you consider investing in startups and early-stage ventures, there always comes a time when things start to get serious, and this is when due diligence comes to play. Due diligence is essential, but it is an exhausting process and conducting it can be challenging to execute and manage.
Financial due diligence is not so much about assessing the economic potential of a particular business but making sure that the financial situation is under control. Depending on why you are doing the due diligence, what you analyse will be different. If you are doing due diligence for a minority investment in a company, you would evaluate the business differently when it is for a Merger or Acquisition.
This article gives you an overview of the due diligence process for the minority investment in new businesses with high growth potential. My goal is to provide you with the tools to understand the summary of your target’s financial history, Shareholders’ Agreement, series terms, cap tables, revenue figures and cash flow.
Even though due diligence investigation is not the most exciting part of angel investing, it reduces the risks and helps you make a successful business decision. To understand the big picture, here are some details you need to know about the past annual and quarterly financial information, including Income Statements, Balance Sheets, Cash Flow Statements, and Financial Projections. Make sure you ask about possible significant economic events after the last statements. I made a complete checklist for you to download.
It is normal to ask a company for all this information before going through with the investment. If a company is unwilling or unable to provide this information, see this as a warning sign.
With this information, you should be able to:
● Review sales and gross profits by product.
○ Check if the company has already done the product-market fit.
○ Understand if the current product is scalable.
○ Understand the prices or sales models used in the past.
○ Check if the plan is based on existing products or new products.
● Check out the rates of return by product.
○ Check the margins of each product.
○ Find the “start” of the company portfolio.
● Go through the receivable and payable accounts.
○ See if there are any large overdue invoices to or from the company and unusual or nonrecurring expenses or income from prior years or expected in the future.
● Get a breakdown of the business’s inventory.
○ Understand how important the inventory is for the company.
○ See how the company accounts for the inventory.
○ Understand the relationship between startups and suppliers.
● Compare past projections with actual results.
○ Try to check the old forecasts and the results achieved by the company.
● Ask for all business tax details.
○ Make sure the company has no unpaid tax or fiscal issues.
● Get a list of all shareholders and current investors.
○ The people behind a startup are the most critical factor. Make sure that you know who the shareholders are and the profile of other investors.
Investment is a multifactor decision. It's essential to check its finances to ensure it doesn't have financial problems. The more information you can collect, the better. In addition to assessing the company's financial health, this is a great way to understand a startup and its dynamics seriously.
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