Due diligence is the process venture capitalists undertake to thoroughly evaluate and vet a potential investment in a startup. It allows us to validate assumptions and identified areas that are risky or not developed enough and will need some more attention or support post-investment.
Typical elements of VC due diligence include:
- Team due diligence — Background checks on founders, management and key employees. Assess skills, experience, motivation, integrity.
- Product due diligence — Testing the product, evaluating UX, features, technology strengths and weaknesses.
- Market due diligence — Research addressable market size, competitive landscape, customer demand, industry trends.
- Financial due diligence — Auditing financial models and metrics, burn rate, cash flow, operating leverage, unit economics.
- Legal due diligence — Reviewing material contracts, IP, pending or threatened lawsuits, regulatory issues.
- Commercial due diligence — Calling customers, requesting demos, assessing sales pipeline and GTM strategy.
- Operational due diligence — Evaluating company infrastructure, policies, tools, security, remote work set-up.
- Background checks — On company, founders, key employees to uncover any red flags.
The depth of diligence depends on the round size and risk, but robust due diligence is crucial for VCs to validate assumptions and make informed investment decisions.
Here are the do’s and don’ts for startups to keep in mind during the due diligence process:
Do be transparent and upfront:
➡️ Disclose all material information upfront, even if it may reflect negatively on you. Don’t try to hide problems hoping the VC won’t find them. Discussing potential problems can really show you if investors are with you for good and bad and if you can count on them to support you in difficult situations. No startup is perfect and we know it so we are prepared to roll our sleeves up and face challenging situations with you.
💡 Example: If you lost a major customer contract, disclose it and explain what happened. Be ready to discuss mitigation strategy and next steps.
Do have financials in order:
➡️ Provide 3–5 years of detailed financial statements, audited if you can.
➡️ Have clear revenue recognition policies.
➡️ Give detailed explanations for profits/losses, burn rates, etc.
💡 Example: Explain why you had a high burn rate last year due to ramping up marketing spend.
Do prepare a thorough business plan:
➡️ Explain your product strategy and roadmap in detail.
➡️ Provide info on target customers, pricing, competitive analysis.
➡️ Have realistic growth and cost projections.
💡 Example: You project rapid growth but should have data to back up your customer acquisition costs and conversion rates.
Do expect straightforward questions:
➡️ Be ready to answer hard questions about your projections, churn rates, regulatory issues, etc.
➡️ Rehearse Q&A if needed so you aren’t caught off guard.
💡 Example: Be ready to explain why churn spiked last quarter and how you will improve retention.
Do have your legal documents ready:
➡️ Provide capitalization tables, shareholder agreements, stock option plan, etc.
➡️ Make sure documents are well-drafted.
💡 Example: Have your lawyer review any shareholder agreements.
Do not exaggerate traction:
➡️ Provide factual data on revenue, customers, usage metrics etc. Do not inflate numbers but feel free to show the potential and have different scenarios.
➡️ Explain the methodology behind your data.
💡 Example: Don’t claim 1 million users unless you can validate that number.
Due diligence is a crucial stage in the venture capital investment process. During this phase, ample trust between the venture capital firm and the startup is essential in order to facilitate transparency and openness. Startups must feel comfortable extensively sharing sensitive information and data with venture capitalists in order for diligence to be thorough and complete. Founders need the assurance that VCs will handle proprietary information responsibly for the ultimate benefit of the startup, not exploit it for their own gains. Given that startups are often revealing their biggest weaknesses and risks during the due diligence process, they need to trust that VCs will not overreact to shortcomings or lose confidence in the company prematurely.
Furthermore, diligence provides strategic opportunities for VCs to advise and mentor the startup team. However, this productive dynamic is only possible if the startup founders trust the VCs’ intentions and input. Establishing a bond of trust also makes founders much more inclined to accept follow-on funding offers from the same VC firm for future rounds. When VCs provide external validation and affirmation of a startup’s assumptions, strengths, or progress based on findings during diligence, founders can trust these endorsements. Overall, mutual trust preserves reputations for both the VC and the startup. Companies avoid feeling mistreated or mishandled, while VCs avoid overreaching or abusing access. By fostering open communication, empathy and aligned incentives during the diligence process, VCs and entrepreneurs lay the foundations for successful long-term partnerships rooted in trust.
