Due diligence for venture capital investment transactions

November 20, 2014

business transactionsAttracting the interest of potential venture capital investors is hard work and founders will need to spend a lot of time polishing up their business plans and the pitches they make to the investors.  Assuming that the preliminary discussions are fruitful, the venture capitalist will want to launch an extensive investigation of the company’s business and affairs, including the background of each of the key members of the management and technical team. There is no standard set of procedures which can be referred to for conducting the due diligence investigation.

The amount of effort will depend on the company, the style of the investors and, to some extent, the size of the proposed investment in relation to the overall portfolio of the investor. In many cases, satisfactory completion of the due diligence investigation and corporate housekeeping process is made an explicit condition to the closing of the financing in the term sheet or commitment letter.

A number of standard tools have been developed for conducting and documenting the due diligence investigation, including document review checklists. A sample form of document review checklist that may be adapted for a venture capital financing is provided in Corporate Equity Financing (§ 154:15).  The document review should always be supplemented with interviews of key company officials, the company’s accountants, suppliers and customers, and other persons having information relating to the company. Ideally all information regarding the company received by the investors and their counsel should be covered by a confidentiality agreement (§§ 200:1 et seq.), particularly data and information that is deemed to be a trade secret (§§ 199:1 et seq.) of the company.  See Specialty Form at § 156:363.50.

The terms of such an agreement are generally similar to any standard form of non-disclosure agreement; however, a significant difference is the acknowledge of the recipients customary business activities including evaluation of companies for investment, preparing reports to its own investors and carrying out duties to other portfolio companies. Many investors will refuse to sign a non-disclosure agreement and if they do they will insist that the company explicitly acknowledge that the investor has the right to invest in other companies that may be competitive to the one they are reviewing under the non-disclosure agreement.