There’s a very good post on venture hacks today on how to close a term sheet quickly. I agree with two-and-a-half of the three hacks1 and want to add a fourth that I think deserves a spot on the summary list:
Have all due diligence ready to go on demand
Due diligence on demand means that the company’s due diligence is always current, up-to-date, and ready to be delivered to a potential partner, investor or acquirer at a moment’s notice.
Given that financing and acquisitions are rare (once a year), this may seem like overkill. But it actually demands that the company keep its books current and in perfect order, which has a number of other associated and equally important benefits.
At Visible Path, we documented our business operations from day one around a typical due diligence checklist that a public company might use when acquiring another public company. The index has 14 sections and 100+ subsections that include corporate governance, stockholder information, securities agreements, material contracts, product and mfg information, government regulations, litigation and audit information, employee information, employee benefit information, financial information, marketing information, property, employee benefit plan matters, facilities. With thanks to Peter Astiz of DLA Piper (who helped me create the original document) and Neal Williams of Carr & Ferrell (who used it to manage our financings and transactions), I’ve attached the actual document here:
Due Diligence Index for SampleCo
The week we incorporated, we only had a handful of documents in these binders: our Certificate of Incorporation, our Bylaws, our founders Employment Agreements, and a cap table describing the ownership of the company. A few documents and about 100 empty tabs. These empty binders seemed a bit silly when we started but as we ran the business – hired employees, filed trademarks, signed up partners, each relevant document was filed in the appropriate section as it occurred, and the binders quickly filled out.
When we signed a term sheet for our series A roughly a year into the business, we were able to simply hit “print” and send our prospective investors the index above and about 4 linear feet of binders that included every necessary document.
This level of preparation can give a big confidence boost to a prospective investor and the law firm handling their due diligence. In the end, diligence is about confidence. It’s extremely rare that a firm will go through every document. The diligence that they do is less about checking every single document and more about getting an overall confidence level that the company is competently handling it’s legal, financial and governance issues.
Twenty bounds of binders meticulously arranged around an index make a good thud on a desk, and the sound is deep and hearty – and gives a good boost of confidence to the folks on the other side of the desk. Even if you never send the complete binders – simply sending the index, explaining what’s behind it, and offering to send select sections as needed, can be a great boost.
Not having diligence ready can have the opposite effect. I’ve seen financings delayed weeks because the company’s documentation is not up to date and the company scrambles to get them in order. Worse, the first diligence package send to the investor’s firm arrives late and incomplete, or contains dated documents with errors. Instead of increasing confident and decreasing the risk around the deal, the exact opposite happens, and the attorneys feel bound to dig in deeper.
Finally, there’s a side benefit to having due diligence on demand that relates to Nivi’s BATNA point: it subtly conveys, without you saying it, that the company is seriously pursuing its round and engaged with other investors.
1 Agree wholeheartedly with point one and point three. I agree with substance of the point two – “set a firm closing date for your lawyers and justify it with something like, ‘I’m leaving the country on that date'”, but not with the tone implied by the point. A firm target closing date is important, but I think an entrepreneur’s relationship with the company’s law firm should to be strong enough that fabricated reasons aren’t needed. The real truth is pretty compelling – you are a start up and any delay in the deal creates risk that you can’t afford. If your counsel doesn’t understand that and demonstrate that, you’ve picked the wrong partner. I avoid prioritizing the pedigree when selecting a firm; instead pick the firm and the partner that understands that you’ve got one company in your ‘portfolio’ that you care about, and will sprint like mad when the company needs it.