Due Diligence (DD)
Due diligence or DD means “research about a company” in investor lingo. It is often divided into two different phases – rough DD and confirmatory DD. The first part is typically the basis for investors to sign a non-binding term sheet, the second for the final investment decision.
The contents of the two phases can vary substantially. Some investors hand out a term sheet after a few discussions and within a week’s time. Others only do this after having studied every single document in your data room.
And obviously there are investors who don’t do any DD besides having a few discussions with the founders. This is typically the case for FFFs, but sometimes even for more professional investors – especially in case of co-investments with renowned lead investors.
Rough due diligence
This is the first phase and the basis for professional investors to sign a term sheet. It typically contains research about the product, market, team and financial perspectives (both of the company and the investment itself). Traction plays a key role, and so do discussions with key persons to understand the potential of the company.
The investor typically does this phase herself.
Confirmatory due diligence
For bigger investment tickets it is typical to do a confirmatory due diligence. This is where auditors go through the details of financial statements and lawyers through employment contracts and IP. As external costs can add up to the tens of thousands of dollars in this phase, this is only done once a principal investment decision has been taken, and a term sheet signed. If the startup has been transparent a confirmatory DD should result in a final investment decision in 90%+ of cases.
The lead investor is typically reimbursed for its external cost in this phase, as it is done in the interest of all new investors. If there is no lead investor it is up to every single party to decide how much diligence is done in this phase, and cost is typically not taken over by the startup.