DreamIt investor Steve Barsh has seen it time and time again: “Founders celebrate early and take their foot off the gas, and then their deal doesn’t close.”
We understand the urge. Due diligence is stressful and overwhelming for founders, because it means someone else is going to take a good, hard look at the guts of your business. Red flags come up all the time and sometimes the smallest missteps can make the difference between a massive injection of funding, a lower offer, or a hard pass.
To help you avoid these missteps, we’ve come up with the most common red flags VCs care about the most. You’ll learn what they are and how to address them if they come up.
1. A disorganized data room
Why it matters: Your virtual data room is how you welcome investors into your business. If you were to invite someone into your home and it was messy, they’d be less likely to come back—the same applies to investors. You may have wowed them with a memorable pitch, but your VDR is where you get serious and show investors why your business is viable.
How to address it: Keep your due diligence documents in one shared space, like DocSend’s virtual data rooms. VDRs make it easy for investors to access and cross-check all the information they need to close the deal, from qualitative customer stories to quantitative revenue forecasts, in one secure location, with one single link.
Bonus: If your VDR includes analytics that show which people are looking at which documents and for how long, you’ll be able to improve your due diligence process with every iteration. It’s especially helpful to see which specific tabs investors are viewing on your financial spreadsheets, so you understand what kinds of information they care about the most.
2. Incomplete financial data
Why it matters: After reviewing financial due diligence documents, investors should walk away with complete knowledge of your company’s profitability, liquidity, cash flows, and overall financial risk. Incomplete data across spreadsheets can make you look unprepared at best and untrustworthy at worst. It can also cause more work on the investor team’s end, as they employ their own financial experts who won’t appreciate the chase for information they assume is included in one package.
How to address it: Don’t start from scratch. First, understand what kind of financial documents you need: financial statements, tax returns, accounts receivable and payable, your capitalization table, and your financial projections. Download our done-for-you spreadsheet templates, including our industry-vetted capital table and financial forecast.
3. Security noncompliance
Why it matters: Security noncompliance is a red flag for investors because it’s an early signal of other operational issues: legal and regulatory risks, potential data breaches, future damage to your business’ reputation, etc. When investors sense that your business may not be following security best practices down to the letter, they become concerned about the financial impact of fines, legal liabilities, and the costs of remediation. Bottom line: security noncompliance can raise doubts about your company’s long-term viability, and it can lead to either a lower offer or no deal at all.
How to address it: Demonstrate security compliance with lock-solid file sharing permissions early in the due diligence process. Invest in spreadsheet and file sharing controls that use viewer-specific permissions to make sure documents are viewed on a need-to-know basis. Use those same permissions to prohibit downloading and forwarding, so recipients don’t even have the option to download or forward your company’s intellectual property.
4. Unclear goals as a team
Why it matters: Whether it’s an exit strategy, more resources for the business, a larger customer base, or something else, clear goals are important to remember when times get tough. Brett Dearing, former senior director at BNY Wealth Management, says that original offers are often reduced by up to 10–30%. These price adjustments can stem from improperly paid employees, outstanding legal claims, misfiled taxes, anticipated future litigation, or a lot more. But when you have clear goals and your team is aligned on them, it’s a signal to investors that you have a clear long-term vision for your company.
How to address it: Align on dealbreakers and dealmakers with your team before the due diligence process happens. Clearly outline what you’re willing to compromise on, and what you’re willing to walk away from if you feel like you’re compromising too much. Prepare yourself for these conversations, push back when the reduction is unwarranted, and keep your eye on the original goal as you negotiate further.
Want a head start on your due diligence documents? Download our done-for-you spreadsheet templates, including our industry-vetted capital table and financial forecast. Let us know what spreadsheet templates you’d like to see next.