Getting Ready for Due Diligence: A Guide for Startup Founders

Due diligence is a critical step when considering investments, mergers, or acquisitions. It involves a detailed check of a business to verify facts and evaluate potential. This guide helps startup founders understand the importance of due diligence and how to prepare for it.

1. Why Is Due Diligence Important for Investors and Startups?

Investors use due diligence to evaluate a startup's potential risks. Though it may seem burdensome, it's vital for startups as its results will serve as a basis for the binding transaction documents.

2. Caveat Emptor: The Buyer's Responsibility

The principle of "let the buyer beware" emphasizes the buyer's duty in due diligence. If you're selling, transparency is key; otherwise, you might be liable for hidden defects.

3. Main Goals of Due Diligence

• Identifying deal-breakers
• Re-assessing the investment's value
• Drafting legal agreements to protect interests

4. Disclosure Letter and Warranties

Warranties may have exceptions, noted in a Disclosure Letter. It's essential to understand what's being disclosed to the investor.

5. Who is responsible for breach of Warranties?

Responsibility often lies with the target company, founders, or other shareholders.

6. Limiting Liability

Liability for some areas, like intellectual property, may be capped at the invested amount. Usually, there is no liability cap for the title to shares and tax-related risks. There are also usual limitations like basket and de minimis clauses, that prevent the investor from making a claim when the breach is insignificant.

7. The Due Diligence Process

The process intensifies with the valuation's size and often occurs during equity financing.

8. Preparing for Due Diligence

Keep your paperwork organized in a cloud storage. Here’re the main sections to review and prepare:

• Corporate documents and fundraising timeline
• Team and employment
• Intellectual Property
• Finances and borrowings
• Taxes & accounting
• Customer contracts & sales
• Regulatory compliance and authorisations
• Data protection
• Usually not relevant for a startup – litigation, insurance policies.

Conclusion

Due diligence isn't just a formality but an essential process for startups. It requires understanding and preparation. With transparency and a proactive approach, you can turn due diligence into an opportunity, not a daunting task.

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