What happens in startup due diligence, and how to be ready
Diligence is where deals slow down or die, almost always over housekeeping rather than substance.
Once a term sheet is signed, investors verify. The process is rarely adversarial, but it is thorough, and the exclusivity clock is usually running while it happens.
Corporate
Formation documents, board and shareholder consents, the cap table, and every equity issuance with its authorising resolution. Investors are checking that the shares they are buying exist and were validly issued.
Gaps here are common in companies that moved fast early, and they take time to remediate because the fix often requires ratifying past actions.
Intellectual property
Confirmation that the company owns what it sells. That means signed invention assignment agreements from every founder, employee and contractor who touched the product.
Commercial
Customer contracts, and specifically change-of-control and assignment clauses. A major contract terminable on a change of control is a real issue at acquisition, and investors look for it early.
Employment
Worker classification, offer letters, equity grant documentation, and any wage-and-hour exposure. In California, classification is examined closely.
Financial
Revenue recognition, the definition behind any recurring revenue figure, churn calculations, and the bank reconciliation. Investors are testing whether the metrics in the deck were built the way they assumed.
“Almost nothing here is a surprise if you have been keeping records. Almost all of it is painful if you have not.”
Practical points
- Maintain a data room continuously rather than assembling one under time pressure.
- Get invention assignments signed on day one, including from founders.
- Track change-of-control clauses in a contract register.
- Define your metrics in writing and use the same definitions everywhere.
