VC Due Diligence Process
The VC due diligence process is the investigation a venture investor runs between a signed term sheet and closing, to confirm the company's claims about its business, finances, legal standing, technology and team.
Reviewed by José Vasquéz, Managing Partner · Last reviewed
Structure
A term sheet is conditional on diligence. The investor has formed a view from meetings and a deck; diligence tests that view against documents, data and references. Diligence also serves a second purpose that founders often miss: it identifies the issues the legal documents must address, such as an unassigned patent or an inaccurate capitalization table. A company that organizes its records before the process starts shortens it and avoids last-minute surprises that reduce trust or price.
Investors usually run five parallel streams.
- Commercial: customer calls, contracts, pipeline, retention and pricing, to confirm that the traction in the deck is real and repeatable.
- Financial: historical statements, bank reconciliation, revenue recognition, burn, forecast and the assumptions behind it.
- Legal: corporate records, the capitalization table, option grants, intellectual property assignments, material contracts, litigation and regulatory compliance.
- Technical or scientific: product architecture and security, or in life sciences the data, protocols and regulatory correspondence, often reviewed by an outside expert.
- Team: references on the founders and key hires, and background checks where appropriate.
The company supplies documents through a data room, a shared folder with an organized index, where access can be controlled and logged. The related questionnaire used by fund investors is described in Due Diligence Questionnaire (DDQ), which differs from company diligence but covers similar themes of governance and controls.
Worked Example
The capitalization table check shows how diligence catches problems. Suppose a hypothetical company has agreed to sell new shares at a pre-money valuation of $17 million and an investment of $4 million. The investor asks for the fully diluted share count, which includes all outstanding shares, options, warrants and convertible securities. The company reports 8,500,000 fully diluted shares.
| Item | Calculation | Result |
|---|---|---|
| Price per share | $17,000,000 ÷ 8,500,000 | $2.00 |
| New shares issued | $4,000,000 ÷ $2.00 | 2,000,000 |
| Fully diluted shares after closing | 8,500,000 + 2,000,000 | 10,500,000 |
| Investor ownership | 2,000,000 ÷ 10,500,000 | 19.05% |
Now suppose diligence finds 400,000 additional shares promised to an adviser in an email but never recorded. The fully diluted count becomes 8,900,000, the price per share falls to $17,000,000 ÷ 8,900,000 = $1.91, and the investor's $4 million buys 2,094,118 shares, or 2,094,118 ÷ 10,994,118 = 19.05 percent. The ownership percentage is the same because the investor negotiates ownership, but the price per share changed and the existing holders absorbed the extra dilution. If the investor had not found the promise, the company would owe shares it did not account for, and the investor would own less than it paid for. This is why investors insist on a reconciled table and why the representation in the purchase agreement covers it. Pricing and dilution are explained in startup valuation for funding.
Running the VC Due Diligence Process Efficiently
A founder can shorten the VC due diligence process by preparing the data room before signing the term sheet. A useful index has eight folders: corporate records, capitalization and equity, financial statements and forecast, customers and contracts, intellectual property, product and technology, employees and advisers, and legal and regulatory. Keep documents current and name them consistently. Appoint one person to answer requests and log each one with a date, so nothing is lost. Answer questions fully and promptly; slow or evasive responses are read as signs of larger problems. When diligence finds a real issue, disclose it, propose a fix and explain how it happened. Investors expect imperfections, and they react more to concealment than to errors. The overall sequence, from first meeting to closing, is described in how to get VC funding.
What It Means for a Limited Partner
A limited partner depends on the manager's diligence to protect capital it will never see directly. The question for an allocator is whether the manager's process is thorough, consistent and independent of the deal's champion. Ask for a sample diligence checklist and a redacted memo, and ask what the manager found that changed a decision. Check who does the work: a manager that relies wholly on founders' statements has not done diligence. Ask how the manager handles issues discovered after closing, including claims under the representations in the purchase agreement. Compare the process with the operational standards in Operational Due Diligence in Private Equity, since a manager that holds its portfolio companies to a standard should meet it too. A record of declined deals, with the reasons, shows whether the process has teeth.
In Life Sciences and Healthcare
Diligence in life sciences and healthcare adds specialized streams. Scientific reviewers examine the data package, statistical plan and the reproducibility of results. Regulatory specialists read correspondence with agencies and assess the pathway and timeline. Intellectual property counsel checks freedom to operate and ownership, including licenses from universities and the assignment of inventions by every contributor. Reimbursement experts test payer assumptions, and privacy counsel reviews the handling of patient data. Because these reviews can take weeks, investors usually start them earlier and run them in parallel with the legal work.
Frequently Asked Questions
What is the VC due diligence process?
It is the investigation a venture investor performs after a term sheet and before closing. The investor tests the company's claims about customers, financial results, legal standing, technology and team, and uses the findings to set protections in the legal documents. It typically takes several weeks and runs through a data room.
How long does VC due diligence take?
It often takes from three to eight weeks, depending on the stage, the quality of the company's records and the complexity of the business. Early-stage rounds can be quicker, and technical or regulated businesses take longer. A prepared data room, one point of contact and prompt answers are the main ways a founder can shorten it.
What documents do VCs ask for?
Common requests include corporate records, the capitalization table, option plans, financial statements and forecasts, customer contracts, intellectual property assignments, employee agreements and any legal or regulatory correspondence. In the example above, a reconciled cap table with 8,500,000 fully diluted shares determined the $2.00 price per share.
Related Reference
Company diligence is the counterpart of the manager diligence that limited partners run on growth equity. Related entries: Due Diligence Questionnaire (DDQ), Startup Valuation for Funding and How to Get VC Funding.