Mishcon de Reya page structure
Site header
Main menu
Main content section
view of city skyscrapers from ground

What founders need to know about due diligence: the devil is in the detail

Posted on 4 October 2023

Arguably the most essential stage of an investment round, particularly in terms of negotiating the round itself, is due diligence. In this article, the second in a series focused on the key considerations for the founders of a company during the course of an early-stage investment transaction, we offer some tips on how founders can best navigate the transaction's DD phase.

An investor will usually send the company a questionnaire, the answers to which will involve the company providing them with certain documents. For example, "please provide a copy of your standard terms and conditions and confirm whether any contracts have been entered into which vary these conditions."

The investor will have teams of individuals poring over the data, analysing what has been included, and similarly, identifying what may have been excluded. Preparing for this stage in advance is crucial, in order to avoid any surprises which could threaten the investment round. The investor will be focused on issues such as liabilities or risks of the company, what intellectual property the company owns, unduly onerous terms or obligations on the company, and its shareholding structure (including any option schemes and levels of control).

Early preparation at the due diligence stage will allow legal teams to review, rectify and highlight any potential concerns prior to an investor raising the same, ensuring a streamlined and efficient process for all. It also means there is time to ensure all documents which are provided by the company are complete, fully signed and dated and to the extent applicable, exclude any documents which have terminated or have expired.

From an investor's perspective, it is important that the company provides full and detailed answers and explanations to each question. The company's answers to the questions tend to provide the bare bones for the warranty schedule contained in the long form investment document. If the company's responses are not clear at due diligence stage, the investor may "bulk up" the warranty schedule, which may lead to a longer, more complex disclosure process.

The DD process:

  1. The company will receive a due diligence questionnaire from the investor and should start to collate the documents needed to answer the questions. The due diligence questionnaire is a non-exhaustive list of all questions relating to the business, including matters such as the company’s shareholdings, employees, intellectual property and a review of the company’s top customer and supplier contracts;
  2. The company should look through the company documents and (i) redact any sensitive information (such as personal details of employees); and (ii) ensure that the document to be supplied is not subject to a confidentiality agreement. If it is, the company may not be able to upload it to the data room;
  3. Investors requesting commercially sensitive information that a company does not yet feel comfortable providing is normal. As the deal progresses, the company will start to feel more reassured that the investment will happen, and at this point the sensitive information can be disclosed (provided a confidentiality agreement is signed);
  4. When sending across the documents or uploading them to a virtual data room, the company should make sure that the documents are numbered clearly and try to utilise a folders and subfolders system that correlates to the due diligence questionnaire;
  5. Once the investor reviews the initial responses, they may make a supplemental request for more information;
  6. Due diligence and uploads to data rooms are an ongoing process throughout the investment round, so the company may want to nominate one person internally to own and manage this workstream.

Due diligence is similar to disclosure (why do they all start with "D's?!"). If something has been provided in response to a due diligence question, the company still need to disclose the information when working through the warranties in the investment agreement at a later point in time. Our third, and final, article in this series will focus on the disclosure process.

How can we help you?

How can we help you?

Subscribe: I'd like to keep in touch

If your enquiry is urgent please call +44 20 3321 7000

I'm a client

I'm looking for advice

Something else