The Dos and Don’ts of Diligence

You’re raising capital and you’ve gotten past the pitch. Now you’re getting into the weeds of diligence. Are you ready to navigate diligence effectively to get the outcome you want? Beyond the obvious attention to detail and responsiveness, there are several key tactical approaches to get the outcome you want.

Nneka Kibuule offers guidance on how to navigate diligence effectively. Nneka is the Principal at Aligned Climate Capital, a firm that invests in the people, companies, and real assets that are decarbonizing the global economy and its infrastructure.

Here’s what to DO during diligence:

1. Diligence is stage specific and product specific

Do your homework on the expectations at this stage for your specific product and prepare accordingly. Align your documentation, data room, and responses to the expectations at that specific stage and for that product.  Talk to other founders at the stage that you’re raising, and friendly investors, and ask them for their suggestions on what to include.

Starting out, you may have done a friends and family round or have gotten angel investment. That lifecycle is very different from a large Series A or Series B. When you’re earlier on as a company, people invest in the founder or the founding team. They’re interested in your vision and your track record of execution.

Once you’ve gotten to proof of concept, perhaps you have a pilot. Now you need to adjust the narrative to show that you have a vision for growth. One key is to validate your previous hypotheses. For example, what did you think about how the market worked, what actually happened, and how did you adjust? At this stage, investors want to see what you’re learning, and what you’re able to do with the tools in front of you. Are you coachable? Be honest with where you’re trying to test and experiment, as well as your strengths and faults. Show that you’re open minded about alternative paths.

Having a clear financial forecast that shows a weighted customer pipeline and how you will use the funds raised to hit key milestones. This should include a map of which resources and hires that you need to make to take your business to the next level.

As you progress forward, the diligence process is no longer just about the vision, now it's about the journey to scale and eventual exit.

2. Put Yourself in the Investor's Shoes

Understand the perspective of each investor doing diligence. Are you talking to a family office, a specialist, or a multi-stage generalist? Be informed about the brand and ethos of that investor. They’ll all look at your deal slightly differently.

Certain investors focus specifically on decarbonization, so they may ask you to communicate a clear view of your carbon impact. Some care deeply about broader ESG metrics, like diversity, and so they may want to understand the demographic makeup of your team. And others have revenue or stage-specific requirements, so they won't consider you until you have crossed a certain threshold of revenue.  It’s important to do your homework on a firm’s past investments and approach accordingly.

By Series A and beyond, investors are looking for a more mature and clean data room. If you have a product in market, make sure that your pipeline matches closely to your revenue projections. Investors want to see customers, pilots or demonstrations, and a strong product market fit at this point. By Series A your business ideas have to be grounded in truth, not potential.

In general, put yourself in the shoes of someone who’s looking for any reason to say no. If you were an outside party asking questions about your business, what would you want to know? Think through the risk in your business and be prepared to talk it through. Being prepared to talk about how you plan to reduce those risks and accelerate growth with the money that you are raising.

For more on crafting a data room that will help you communicate clearly, check out this insight with Susan Su.

3. Know Your Customers

Set up several good references with key partners or customers that you have worked with closely, who can talk meaningfully about your business. Keep in mind that customer is a broad term – who are you selling to? Who makes the purchasing decisions? Who does the onboarding for your product? How are you taking feedback from them?

Depending on your product, not all customers will be able to speak in depth, but make sure some of your references are able to go into detail. Investors may ask questions like: Did everything go as expected? How does this product compare to similar ones that you have tried? If they’re talking to a partner, they may ask: How did this team react when things didn't go as expected or when there was a hardship? What's the team dynamic together?

If all your references are giving cardboard answers or lukewarm responses, this is a sign to investors that you don’t know your customers and they don’t know you very well. They want to see that you are truly in communication with the people who matter most to building your business.

If you get hard questions during the diligence process, here’s what NOT to do:

1. Assume that the investor’s questions are coming from a good place

If an investor sends a diligence questionnaire or asks follow up questions that you don’t have an answer for, don’t be dismissive. Founders will sometimes come back with, “this other fund never asked for that info,” or “this brand name is already an investor and they didn’t care about that.” Many times the investor is trying to learn as much as possible to make a quick decision or vouch for you with their team. If you react defensively, investors might think that you might have something to hide, you don’t value this investor compared to others, or that you’re not a team player.

It’s okay to say that you don’t know the answer or even that your team doesn’t have the capacity to answer without additional support or time. Investors are also trying to assess the level of internal governance or formal operations you might have. For example, it is very common for early-stage companies to not track their Scope 1 or 2 emissions because they are more focused on building their solution or product. The questions are coming from a good place so there is no need to feel defensive.

2. Don’t Create Fake FOMO

Sometimes founders will try to drum up FOMO by saying, “The round is going so fast, so many people want this” as a means of accelerating the diligence process.  Unless you have a term sheet in hand from another investor, don’t lie and say that you do. This tactic might have the opposite effect than intended. Investors that you don’t have a strong relationship with may withdraw from the process because they don’t think they can run their diligence process fast enough.

Instead stick with the truth – If you do have several investors that are moving slowly you can set a due date for term sheet submission. That way you can see who is serious about the process, while communicating to the investors that there are multiple entities in diligence.

Remember, you’re building a long-term relationship with a partner, and if it's not built on trust and honesty, it's not going to go well in the long run. Foster a collaborative working relationship and build mutual trust from the start.

3. Don’t assume that an easy check will make for an easy relationship

Fundraising can be a long process full of rejection before you find the right capital partner. If an investor writes a check quickly, It can be tempting to say yes right away.  Do your homework on investor expectations and talk to some of their portfolio companies for reference; in some cases, “easy” money becomes “hard” money very quickly.

Nneka Kibuule is a Principal at Aligned Climate Capital where she invests in energy, sustainable land use, clean transportation, resilient and efficient infrastructure startups. Previously, Nneka worked at Elemental Excelerator, Pacific Gas & Electric, and NextEra Energy Resources. She holds an MBA from Kellogg School of Management, a Masters in Energy Finance from Tulane, and a BS in Finance from Hampton University. She is the founder of GreenTech Noir a collective for elevating Black Founders, investors, and talent in ClimateTech.