Navigating Due Diligence: Transparency and Risk Mitigation
Takeaway: Due diligence is an exhaustive, investor-led audit of your entire company; approaching it with organized transparency and a proactive risk mitigation plan is the key to building trust and closing your round.
You’ve made it through the pitches, you’ve impressed the partners, and an investor is interested. They’ve given you a term sheet. This is a huge moment, but the deal is not yet done. Now comes the final and most rigorous stage of the fundraising process: due diligence.
Due diligence is the formal process where the investor and their team of experts—lawyers, accountants, and scientific consultants—conduct a deep, exhaustive investigation into every aspect of your company. Their goal is to verify that everything you've claimed in your pitch is true and to uncover any hidden risks before they write the final check.
How you handle due diligence is just as important as your pitch. A transparent, organized, and proactive approach builds trust and signals that you are a professional, high-quality team. A chaotic or defensive approach can kill a deal, even with great science.
The Anatomy of Diligence: What They Will Ask For
The diligence process revolves around a "diligence request list," which is a long list of documents and information you will be expected to provide. These requests cover several key areas:
Scientific & Technical Diligence: This is often the most intense part for a biotech company. The investor's experts will want to see your raw experimental data, lab notebooks (hopefully a well-organized Electronic Lab Notebook - ELN), and detailed protocols. They will re-analyze your results and pressure-test your scientific conclusions.
Intellectual Property Diligence: Prepare for a deep dive into your IP portfolio. Their lawyers will review every patent application, analyze your freedom-to-operate (FTO) reports, scrutinize the terms of any university in-licenses , and confirm that every employee has signed an IP assignment agreement. Any cloudiness on your IP ownership can be a deal-killer.
Corporate & Legal Diligence: They will review your certificate of incorporation, bylaws, board minutes, and any major contracts. They need to see that your company has been set up and managed with good legal hygiene.
Financial Diligence: They will examine your financial statements, projections, and capitalization table (cap table) to ensure they are accurate and that the company's ownership structure is clean.
Team Diligence: They will perform background checks on the key founders and will want to speak with your references and key scientific advisors.
The Winning Strategy: Radical Transparency
The key to navigating due diligence successfully is to embrace it with radical transparency. Do not try to hide or downplay risks. The investors and their expert teams are professionals; they will find them.
Prepare Your Virtual Data Room (VDR) in Advance: Before you even start pitching, you should have a secure, meticulously organized online data room containing all the documents you know investors will ask for. A clean, well-structured VDR signals competence and makes the process smoother for everyone.
Create a Disclosure Schedule: The most sophisticated founders take transparency a step further. They create a "Disclosure Schedule" or "Issues List." This is a document where you proactively list any known risks or potential issues (e.g., a potential patent conflict you are monitoring, a tricky clause in a licensing agreement, a pending operational challenge) and—this is the crucial part—you outline your plan to mitigate that risk.
Be Responsive and Organized: Assign a point person from your team to manage the diligence process. Respond to requests quickly and thoroughly. If you don't have an answer, it's better to say "we're looking into that and will get back to you" than to guess or provide incomplete information.
Discovering a problem during diligence is not necessarily fatal. Discovering that a founder tried to hide a problem almost always is. By approaching diligence as an opportunity to build a partnership based on trust and transparency, you can turn what feels like an interrogation into the final, collaborative step before closing your round.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.