My tips for VC Due Diligence and closing the VC deal

Over the years people have often approached me with questions like "what we need to do in order to be ready for VC investment?" "what's there to prepare?" etc. Often it seems that companies and their founders know more about raising capital than closing the actual deal in the end.

I will be writing more on this topic, perhaps even a series of posts, so I'll start with some rather summarized tips. Feel free to jump into the conversation and agree/disagree with these.

1. It takes time to close. Sometimes up to 6 months. So you need to have time, and you need to have an attitude that you are in no hurry. Never ever plan your business based on any dates when "the money will be there", because often it won't. There are positive surprises, but they are exceptions to the rule.

2. Do your homework very well regarding the Due Diligence process the VC will have to do anyways. Proper DD includes pretty much everything, but focuses especially on: IPR, Legal and Technical. Have those areas covered as well as you can. Some good practical tips are:

A. Maintain an active IPR registry. This can be done in Google Docs or where ever. Can be quite simple and it should be something everybody has access to. A good registry has every IPR, idea, concept, design, component etc (you get the idea) written down in a headline level and a brief summary on how it works. Many of the companies in this space primarily only own IPR (and nothing else of substantial value) so doing this register is quite vital. You can also verify the register as prior art by having it time-stamped officially in the local magistrate. If you need (and can afford) the help in building a registry like this these people are some of the best in the business here locally in Finland. Why is this important? When a professional VC sees a beautiful all-inclusive IPR registry with summaries they will be very happy. Makes their DD job a lot easier and also plays positively in the psychological side: clearly this is a company that knows its stuff! As a benchmark the IPR lists of some of the companies I have run have been about 35 pages with only the headline and 1 row of summary for each IPR. Just saying that if you do this right you will end up listing a whole lot of stuff (which is good).

B. Legal DD is next: have your IPR list time-stamped by the magistrate every once and a while. That way you can prove that the idea/concept/etc existed at some point in history, and if it did enter public domain at that time it will be a lot harder for anybody who might patent the same thing later to stop you from using it, since you can prove you had it already. Have all of your legal documents (employment contracts, SHAs, board meeting minutes, NDAs, agreements, etc) in one place: one directory in digital format with only the final signed copies in there (no drafts), and one folder full of paper. In addition to this most bigger companies maintain a registry/list of all the contracts they have: this can be a similar brief list, listing contract names, dates, person who signed, and the other party's name etc. Having all this in neat order will help you alot when the legal DD hits. Usually VCs use a contracted lawyer or some other professional expert to asses your stuff. When they encounter a neat pile of paper with complete lists etc they will be impressed. Believe me, most startups don't do this part very well and they have to hunt for the papers in the DD, makes you look really unprofessional. Your local lawyers can help you get "DD ready", some law firms I have worked with: AKG, Borenius & Kemppinen, Fennica (or BIrd&Bird nowdays).

C. Tehcanical DD is pretty straightforward: you need to document and maintain your technical stuff in the IPR registry as well. One of the most important things; be sure to write understandable prioritized documentation and functional descriptions on how your stuff works. Use plenty of graphics. Remember: this is primarily a document your are preparing for an outsider to read - so feel free to highlight the really important stuff and to underline the uniqueness of your solutions. Allows them to "grasp it" faster. Think of yourself going through the tech in a random technie company: how would you want to read about it? source code directly? good documentation? What ever it is, prepare it well and have in a neat pile like the rest of the DD stuff. And make sure your top technical people have the competence to talk about the details in a manner that represents you positively.

D. The rest: during a DD process the VCs often i) look through everyones CVs, ii) interview everybody (or almost everybody) in the company. So have your CVs ready, prepare your gang for the interviews. Resolve any and all internal issues and conflicts before the talks: it can get nasty if VCs talk your people in the middle of some internal hickups.

Even great companies can get this stuff "wrong", as highlighted by TechCrunch in this posting about how Google walked away from Digg because of "technical due diligence was to blame" and "Digg's top team just wasn't a fit".

Scandinavia/Finland also must have cases that have failed during the DD phase - do you know of any? People never talk about those..

This is ending up to be a pretty long post, so I'll share one more tip and continue this later in another post then:

3. Pressure the VCs. Don't have just one alternative around, have several. Don't be "begging for financing" but rather "on the market shopping for financial services, as the customer/buyer". VCs are financial services vendors to the startups and the startups ARE the customers. The price you pay is equity, but they need to sell their services to you just as well as you need to prove you are a good "catch". It's not unlike humans pairing up ;-) shares many of the similar concepts on how you finally end up between the sheets together. The best position for a startup is to have several VCs competing on investing to you. At the very least you need to have (and to build) alternatives. I plan to blog about a couple of war stories were this was successfully done.

To be continued..