What I look for in a Due Diligence Binder

I've received lots of comments on my previous post about creating a Due Diligence Binder. As I mentioned previously, you want to provide your investor adequate information for them to research you and your company. The more you provide, the better they can evaluate you. While some entrepreneurs may be leery at providing this kind of proprietary information to outsiders, you must understand that your investors will be spending money to investigate you - take this as a sign that they are serious about your company. If you desire, you can make them sign non-disclosure. If you are paranoid, you  might go as far as setting up a clean and confidential room such as may be used in an M & A process. One easy alternative is to create a truncated DD binder and leave out key pieces that may be requested as appendices.

So here is what I like to see in a solid DD binder:

1. Background of company since inception
2. Background of key personnel
3. Business plan and all previous versions, including exit strategy
4. All correspondence to previous investors
5. All audited and unaudited financials since inception
6. Discussion of performance
7. Capitalization Table
8. Lease agreements
9. Employment agreements
10. Purchase or sale agreements
11. Previous letters of intent

As I mentioned in my last post,  if you are just starting up, you want to have reporting processes in place that make it easy to update this DD binder on a quarterly basis. You want to be able to get this out to people immediately if they request it. If you are an established startup and are now just putting together a DD binder, your investor will probably be able to see that you are not that organized and that you really haven't done this before. This may or may not pose a problem, but if your financials and accounting are crisp and clean and you have a nice reporting system in place already then your investor will surely know that accountability and reporting are not going to be an issue.

In this day and age of electronic networks, there are various on-line reporting systems that are used by private companies or investment companies to deliver correspondence. Many open-minded institutions post all of this information that might be included in a DD binder on this network and make it available to potential investors. I will admit that this is somewhat rare, but I have done due diligence before on a firm that gave us access to their intranet that contained all correspondence and reports for all of their previous and current funds. Suffice it to say that we found no holes in any of their documents and reporting and they have one of the cleanest books that would make any LP sleep comfortable at night.

As you can imagine, this is a generic list of items that will need to be tailored according to industry or type of company. For example if your startup is an investment company or private equity firm, you will want to focus more on track record and perhaps investment strategy. You may want to include a list of previous investors or key LP relationships or even letters of "soft" commitments from LPs to shows that you will not have problems raising investment funds. Because investment firms tend to rely on key personnel, one thing I do like to see is a discussion of exit strategy of the key principals including how long they plan on being with the company and what their personal investment in the firm has been to date.

Feel free to let me know if you have any additions or questions.

Comments

[Don Jones]

I've seen all types of startups, from the very open to the paranoid. Very few are aware of the due diligence process and how they can create a good impression and beginning of a relationship. Hope word gets out...

[Inquisitor]

While few startups are familiar with DD and these are very useful tips, I think most early-stage companies are more concerned with getting customers rather than being organized for investors. Every time I see a deal where a company is disorganized, I say, "Wow, if I were starting a company I would do this so much better..." then I think, "Wait a second, no I wouldn't, I would be killing myself to get customers first."