is any investigation by one party of another party. When used in a fund raising context, it usually refers to the investigation conducted by a prospective investor into the background of a company, its management team, and the statements and assumptions contained in it business plan. It is usually intensive, time consuming, and thorough. It is not unusual for the investigation to take weeks or months to complete.
Due diligence customarily includes background checks on the management team, independent verifications of statements made in the business plan, and studies of the company's product and market. It includes extensive questioning of management and other company personnel. Most venture capitalists will talk with company suppliers, customers, competitors, and others who know the company and its industry.
Entrepreneurs should conduct due diligence too. They should investigate their industry and their partners thoroughly to gauge their company's prospects and the depth of experience and commitment of each of its principals. Business plans should not be completed without giving careful attention to the assumptions and "facts" that support the company's profits and cash flow projections.
Just as important, entrepreneurs should conduct due diligence investigations about the company's potential investors. Selecting the right investor for a company can mean the difference between success and failure. A disreputable or reluctant investor can slow and even prevent company success. Conversely, an honorable investor can help management by giving it the benefit of his experience with growing companies and his contacts with financial institutions. This can be as valuable as cash.
One way to learn about a particular investor is to ask bankers, lawyers, and accountants about his reputation. If a publicly held venture capital fund is considering investing, a good deal of information about it can be obtained from the Securities and Exchange Commission. If it is privately held, management can usually obtain a copy of the offering circular it used to raise funds by simply asking the investor for one. The National Venture Capital Association, National Association of Small Business Investment Corporations (NASBIC), The Corporate Finance Sourcebook and Pratt's Guide to Venture Capital Sources by Stanley Pratt can also provide valuable information about the size of a fund and the types of investments it makes.
Once it has begun investigating a company, most venture firms will give an entrepreneur a list of the companies in which it has invested. These companies can provide valuable insights into the operations of the fund and its desirability as a business partner. Appropriate questions to ask the founders of these companies are:
The more specific the questions are, the more valuable will be the information obtained. Questions to and about the venture capital firm are appropriate and demonstrate management's concern for the future. Questions about how long it will take the investor to make a decision and whether it has the funds and freedom to make an investment are particularly appropriate. See: Audits, Business Plan, Downside, Ethics, Five Factors, NASBIC (National Association of Small Business Investment Companies), National Venture Capital Association, Three Questions, Venture Capitalists.