Updated: Mar 7
Seeking external funding can be a daunting task for business owners. It requires careful consideration and an understanding of the risks involved for both the business and the investors. This is why investors go through a process called due diligence to evaluate the potential risks and rewards of investing in a company — an essential process to understand for business owners seeking external funding. Here, we explore what steps should be taken before making such a decision and why going through the due diligence process pays off in the long run.
Due diligence helps to manage risk by ensuring that all necessary information is collected and assessed before making any financial commitment. This can involve legal research, financial forecasts, profitability analysis, market trends and more in order to gain a comprehensive view of the venture’s prospects before any money changes hands.
Two-sided due diligence
When looking for external funding, due diligence should be applied to both sides – both the investor and the business seeking capital must evaluate each other beforehand; taking into account parameters such as investment strategy, risk tolerance level and return expectations. By assessing these aspects upfront, potential conflicts or misunderstandings can be avoided down the line when both parties have a better understanding of what they are getting themselves into.
Key Areas of Preparation
Here are some key areas that business owners should focus on when preparing for due diligence:
Financial Records: Business owners should have accurate and up-to-date financial statements, tax returns, and bank statements available for review.
Systems and Processes: Business owners should have a list of software and tech stack subscriptions along with documentation of processes and controls available for review.
Legal and Regulatory Compliance: Business owners should ensure that their company is compliant with all relevant laws and regulations, including tax laws, labor laws, and environmental regulations.
Intellectual Property: Business owners should ensure that they own all of their intellectual property, including trademarks, patents, and copyrights.
Operational History: Business owners should have a clear understanding of their company's operational history, including sales and marketing strategies, customer base, and supply chain.
Management Team: Business owners should have a strong management team in place, with experience and a track record of success.
Perform self-due diligence
Here are some reasons why business owners might want to prepare for due diligence even before soliciting outside funding.
Demonstrating Company Strengths: By being prepared for due diligence, business owners can demonstrate their company's strengths, making their company more attractive to potential investors. A thorough understanding of the company's financial and operational history, legal and regulatory compliance, and intellectual property can showcase the company's potential and growth opportunities.
Mitigating Potential Risks: Due diligence can also help business owners mitigate potential risks. Identifying and addressing any issues or potential issues in the company's financial and operational history, legal and regulatory compliance, and intellectual property can reduce the likelihood of any negative surprises during the investment process.
Enhancing Decision-Making: Due diligence can also help business owners make informed decisions about their company's future. By gaining a deeper understanding of the company's strengths and weaknesses, business owners can identify areas for improvement and make strategic decisions about their company's growth and expansion.
Preparing for a due diligence prior to starting any negotiations for external funding may be useful in terms of managing risk as well as avoiding potential pitfalls along the way. It may seem like a waste of time but ultimately preparation is key to getting your business funded. For assistance with the due diligence of financial records, GFT is an accounting and finance outsourcing solution that can help.