As explained in other posts, a Due Diligence (“DD”) is an audit conducted on a company to determine whether it is up to date with its obligations and compliance in the most important areas.
DDs can vary in depth, nature (financial DD, legal DD, tax DD, technological DD, etc.), and scope depending on their purpose (investment, acquisition, commercial agreement, etc.), as well as the stage of the startup. In this article, we will focus on explaining the role of DD in the context of investment operations.
Why conduct Due Diligence in investment operations?
When a startup is seeking funding, it must provide certain guarantees and security for investors. That is, since investors such as business angels or venture capitalists are going to invest in the startup, they need to analyze the viability of the startup and evaluate potential risks before committing their capital. In this context, DD plays a key role, as it allows investors to perform this analysis to provide a clear and detailed view of the startup in which they intend to invest.
Thus, DD becomes a common and preventive mechanism used to make informed decisions before investing. It becomes even more relevant in startups, as without a consolidated history backing the investment decision, risks for potential investors are greater, making this process key to assessing the project’s viability. Once the startup founders and investors have signed a letter of intent, the due diligence process begins.
Main objectives of Due Diligence in the investment framework
Below we list and analyze the main objectives of DD in the investment context:
- Evaluate business viability: analyze the business model, market, competition, and growth capacity of the startup.
- Identify risks and contingencies: detect potential legal, financial, tax, or commercial issues that may affect the investment.
- Optimize negotiation: provide key information to help investors better structure the operation, define terms and conditions, and mitigate risks.
- Determine the real value of the startup: establish a fair valuation based on objective data and realistic projections.
- Ensure transparency: ensure the startup provides truthful and complete information, generating investor confidence.
Due diligence processes, as well as their timelines, vary depending on the nature and scope of each case and can last from weeks to months. During this period, an independent third party, separate from both the startup and the investor, performs a thorough analysis in several phases. First, an initial phase identifies key points; then comes the investigation phase, where the third party examines all gathered information. Finally, the conclusion phase involves preparing a detailed report presented to the investor, including both the analysis and relevant observations and other key data within the investment context.
In conclusion, DD is a fundamental tool for closing an investment, as it allows detailed analysis of a business’s potential and makes it attractive to investors. In the context of startups, external investment is key to growth and consolidation within the ecosystem, so DD becomes an indispensable tool for any entrepreneur seeking to remain competitive in the market.
Article written by:
Lawyer – Corporate and M&A
pilar.casasnovas@metricson.com
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