Before investing in a company, venture capitalists run what is called a due diligence checklist. This is a rigorous process that looks closely at all aspects of a company, including assessing business legal, financial, and human resources status. By performing a thorough review of the company, investors can move forward with their investment with confidence.
Additionally, the due diligence process helps investors gauge the potential risks and rewards of the investment. If the due diligence results are sound, usually the investors will move forward.
To help you understand exactly what company details are reviewed closely, we discuss each part of the checklist.
What is Due Diligence?
Venture capitalist firms use due diligence to ensure that potential investments are sound and will generate a good return. This process allows venture capitalists to evaluate the potential risks and rewards associated with any given investment, as well as gain a better understanding of the company and its operations.
This process looks at a variety of sources, including the company’s financial documents, legal documents, market research, and other related material. Additionally, venture capitalists may consult with experts such as lawyers, tax advisors, and industry analysts to gain a better understanding of the company and its prospects.
Ultimately, due diligence can help venture capitalists make informed decisions about which investments to pursue.
Types of Due Diligence
Venture capitalists will look at more than just a company’s financials to get a comprehensive view of the company’s standing.
Financial Due Diligence
Financial due diligence is a process in which an independent third party reviews the financial records and operations of a company to assess its value, financial strength, and potential risks. The goal is to provide an informed opinion on the company’s financial position and future prospects. It is typically conducted prior to a merger, acquisition, or other business transaction.
This step looks at the market, top competitors, required permits or permissions, and who the company can or can’t conduct business with.
Regulatory Due Diligence
Regulatory due diligence evaluates a company’s compliance with applicable laws and regulations. Existing shareholders, certificates of incorporation, existing contracts and/or arrangements, and other rights pertaining to the company capital are all examples of what investors will evaluate. A look into these areas makes sure that any investment made in the company will be in compliance, especially if the company has had any previous legal disputes.
Tax Due Diligence
Tax due diligence is a process of assessing the tax compliance of a company by reviewing tax laws, tax returns, and financial audits. Venture capitalists use it to guarantee that any investments they make follow tax regulations and that the company’s taxes are being paid properly.
Tax due diligence gives investors greater insight into the tax implications of their investments and identifies any potential liabilities.
Legal Due Diligence
Legal due diligence evaluates a company’s compliance with legal requirements, again, to make sure everything is compliant with regulations. Investors will look at shareholder resolutions, a certificate of incorporation, previous capital charges, and any contracts that could be terminated. Legal due diligence helps identify any potential issues that could affect the investment.
Intellectual Property Due Diligence
Intellectual property due diligence is a process of assessing the patents, copyrights, and trademarks held by a company. It ensures that investments don’t violate existing intellectual property rights and helps identify any potential IP issues that could affect the investment.
Information Technology Due Diligence
Information technology due diligence evaluates a company’s IT systems, processes, and procedures, as well as if the company is exposed to cybersecurity risks. Venture capitalists use it to ensure that any investments they make are supported by a strong IT infrastructure.
Human Resources Due Diligence
Human resources due diligence is a process of evaluating a company’s human resources policies and procedures, including its workforce mix, benefits, salaries, and bonuses. It’s not uncommon for investors to request organizational charts, stock options, and benefits packages, the details of past disputes with employees, and contact information with all third-party vendors.
Operational Due Diligence
Operational due diligence is a process of evaluating a company’s operations, including current processes, supply chains, logistics, procurement efficiencies, and risk management. Venture capitalists use it to make certain that the business is running well and can support any future investments.
Risks of Not Performing a Complete Due Diligence Check
If venture capitalists fail to use a due diligence checklist, they may expose themselves to unnecessary risks with costly outcomes. Without a thorough review of the company’s financial records, management team, industry trends, competitive landscape, and other operational matters, the venture capitalist may not have a full understanding of the company and its prospects. This can lead to poor decisions and a potential loss of funds. Additionally, it can increase the risk of legal and financial issues associated with the investment.
In Summary
The due diligence process is one of the most important steps that venture capitalists take, and working with a financial partner like Lavoie, can ensure the due diligence findings are as accurate as possible.
An outsourced accounting firm like Lavoie has the resources and expertise to evaluate the potential company’s financial statements and financial health and provide guidance on potential risks and rewards associated with the investment. Additionally, a venture capitalist accounting company can provide advice on tax liabilities and other financial matters associated with the investment.
Consult with Lavoie to prepare for your upcoming investment. Contact us online today.