Financial Due Diligence: What Investors Really Want to See.

Imagine this: I’m sitting in a meeting room, or perhaps virtually connecting with a founder who has just pitched their idea. I’m excited. The idea sounds promising, the team seems capable, and the market potential is huge. But now comes the next part—financial due diligence. For many founders, this phase can feel like stepping into the unknown, filled with spreadsheets, documents, and the fear that one misstep might cost them a valuable partnership. Let me demystify this process and share what I, as a VC investment professional, truly want to see during financial due diligence.

Why We Conduct Financial Due Diligence

The word "due diligence" often conjures up images of magnifying glasses and endless probing, but for us VCs, it’s more than just checking numbers. It’s about building trust. We need to know that your startup is built on a solid financial foundation and that you have a clear grasp of your financials, your market, and your future. Financial due diligence helps us validate your story—ensuring your startup is not only surviving but has the potential to thrive.

This stage is crucial because we’re about to partner with you on a journey that will require both financial backing and strategic guidance. To support you effectively, we need to understand how financially resilient your startup is, how you’re using your resources, and where you’re headed.

What We're Looking For: The Documents We Review

The documents we ask for during due diligence aren't just "nice to have"—they’re windows into how you operate. Let me break down what we typically look at and why these documents matter:

1. Historical Financial Statements: We need to see at least the past two to three years of your income statements, balance sheets, and cash flow statements. These help us understand your revenue growth, cost management, and how effectively you manage cash. Trends here tell us if the company is ready to take on the growth you're pitching.
2. Forecasts and Projections: Your growth story is exciting, but we need to see the numbers behind it. How realistic are your revenue targets? How do you plan to achieve them? Providing detailed forecasts (ideally broken down by month or quarter) helps us understand the scalability of your business.
3. Cap Table: We review the cap table to understand the current ownership structure. This gives us insights into how future investments will impact the shares of everyone involved. It also helps us assess any complexities or red flags in existing agreements.
4. Contracts and Liabilities: We want to know who your key customers, suppliers, and partners are, and if any liabilities could create risks down the road. It’s not just about the money—it’s about relationships, stability, and understanding the commitments you've made.
5. Revenue Recognition and Unit Economics: This is about understanding how value flows through your business. Whether it's a SaaS model with monthly recurring revenue or a product-based business relying on one-time sales, we need to see clarity in how you recognize revenue and how sustainable that is.
6. Tax Compliance and Filings: Taxes aren’t glamorous, but they can create big headaches. We review your tax filings to ensure there are no pending liabilities and that everything is compliant.
7. Debt and Obligations: Any outstanding loans or financial commitments are scrutinized to understand repayment obligations and the impact on your cash flow. The last thing we want is to invest and find out if the startup’s growth is hamstrung by an unknown debt burden.

Setting Up Your Data Room: What We Expect

The data room is where we get a complete picture of your financial health. Think of it as a well-organized library—a place where we can easily find the answers to the questions we have. Here’s what an ideal data room looks like:

1. Well-Organized Folders: Each document should be neatly sorted into folders like "Financials," "Contracts," "Tax," and "Legal." Make our job easy—if we have to dig to find information, it is time-consuming and raises questions about your organizational skills and attention to detail.
2. Up-to-date Information: We understand that things change quickly in startups, but the documents must be as current as possible. Nothing frustrates investors more than receiving projections from two years ago or incomplete financial records. We want to see today’s snapshot, not outdated history.
3. Clear Version Control: Make sure we’re all on the same page. If you update a document, ensure there’s a note to indicate changes. This helps us track your progress and provides clarity on the current state of the startup.
4. Accurate and Consistent Data: Consistency matters. If your cash flow statement tells a different story than your income statement, we’ll notice, and it’ll raise red flags. We want to be confident that the numbers align.

How We Analyze: What We're Looking to Find

Financial due diligence isn’t just a box-checking exercise. There is a thorough analysis behind it, which may vary depending on the sector of the company being evaluated. However, the basic information being analyzed is listed below:

1. Trend Analysis: We want to see consistent growth. Erratic revenue spikes or periods of unexplained decline are signals. The trends tell us if your growth is healthy and sustainable.
2. Ratio Analysis: We use ratios like liquidity, solvency, and profitability to assess your financial health. Ratios help us understand how well you’re managing cash, debt, and profitability compared to industry standards.
3. Burn Rate and Runway: As a startup, you’re likely burning cash. We need to understand how quickly and how efficiently. How many months of runway do you have left? Do you have a plan to raise more when the time comes?
4. Unit Economics: CAC (Customer Acquisition Cost) and LTV (Customer Lifetime Value) are two key metrics we focus on. We want to ensure that your business model makes financial sense—spending more to acquire customers than their lifetime value is a sign that scaling will be difficult without changes.
5. Scenario Analysis: What if things don’t go as planned? We’ll look at worst-case scenarios to understand how resilient your startup is under different conditions. Having multiple plans shows preparedness, which we value highly.

How to Ace Financial Due Diligence: What You Should Do

Here’s the good news: financial due diligence doesn’t have to be intimidating. Here's how you can make sure it’s a breeze:

1. Be Transparent: If there’s a problem, tell us upfront. No business is perfect, and as investors, we understand that. Hiding issues will erode trust and likely kill the deal. It’s better to show that you understand your challenges and have a plan to tackle them.
2. Show Your Metrics: Revenue growth, LTV ratio, churn rate—know these numbers well, and ensure they’re easy to find in your data room. Please show us the KPIs you track, and why they matter for your business.
3. Stay Consistent: Consistency across all your documents is critical. Ensure your financial statements match up with your records, and that your projections make sense in the context of your past financial performance.
4. Keep It Professional: Be timely and organized in your responses. Investors notice professionalism, and being prepared indicates that you’re ready to take on the responsibilities that come with funding.

What Not to Do During Due Diligence

While preparing for financial due diligence, there are a few common pitfalls that can derail your process:

1. Don't Delay: Delays signal disorganization or worse—potential issues you’re trying to hide. Prompt responses show that you’re on top of your business.
2. Don't Overstate Projections: Your projections need to be ambitious yet achievable. We want to see that you’re aiming high, but not to the point where it becomes unrealistic.
3. Don't Hide Problems: Any undisclosed debts, pending lawsuits, or other liabilities will eventually come to light. Full disclosure demonstrates integrity, and it’s much easier to work through issues when everyone’s informed.
4. Don't Be Unprepared: Don’t enter the due diligence process with incomplete records. Missing information creates friction and suggests that you’re not fully in control of your business.

Financial due diligence is a vital stage of the investment process. As a VC, I’m not only looking to see the numbers but also how you manage them and if you have the potential to grow. Investors need to feel confident that your startup is financially resilient, organized, and capable of taking on new challenges.

Transparency, readiness, and consistency will help you successfully navigate this stage. The goal isn’t just to tick the boxes; it’s to build a foundation for trust and a lasting partnership between you and your investors. Remember—this is not about passing a test but about showing that your business is ready for growth and that you are ready for the next step of the journey.