What is due diligence?
If you are a company looking to raise capital, whether debt or equity, chances are you have heard the term “due diligence” before. In the simplest terms, due diligence refers to the process by which an investor or lender verifies the representations made by a target company preceding a funding event. What this really means is that due diligence can vary substantially based on the specific capital partner and the amount of funding offered. So how can a company prepare in advance if they are anticipating a need for a capital raise?
How to prepare
- Understand the basics
While there is a wide array of requests made during due diligence, the large majority will focus on the target company’s financial statements and financial health. Good record-keeping is key here. Companies communicate just as much through their direct financial statement support as they do through the time it takes to get that support together. The longer it takes to prepare and provide all of the relevant support, the less organized and reliable the company will appear. By contrast, a company that can produce supporting records upon request will communicate greater sophistication and overall competency. This point cannot be emphasized enough. Funding can (and will) quickly evaporate if due diligence gets dragged out or requested documentation cannot be provided timely.
- Seek the right kind of assistance
If there is any concern over the state of the financials, it is imperative to get a CPA involved as soon as possible. Financial clean up can take a substantial period of time and come at a high cost. This is why it is essential to understand that not all CPAs are created equal, and many business owners are not aware that accounting standards vary between industries. Additionally, accounting standards vary based on the structure of the entity and chosen basis of accounting (such as cash basis, accrual basis, or tax basis). In other words, simply being a CPA does not immediately mean an accountant will be able to prepare proper due diligence support. The chosen CPA should have a background in audit (like those at Rebel Rock) and the respective industry you are operating in, at a minimum.
- Be realistic about your timeline
As mentioned above, financial statement clean-up can be very detailed and time-consuming. The last thing you want is to get a term sheet signed, only to have definitive agreements fall apart when you cannot promptly produce your due diligence requests. If you are confident that your financials are in relatively good condition, plan at least 1-2 months working alongside a CPA to make sure you are prepared for any due diligence request. If you are concerned about the condition of your financials, plan a minimum of 6 months of detailed attention to getting your books in order.
We are Here to Help!
It is important to keep in mind that you are bringing a CPA in for a reason. While it may seem hard to understand why certain balances require more attention than others or why the process seems to be taking so long, it is imperative to listen to their advice. Your CPA is there to help! And most importantly, even if you utilized a CPA’s work, the company’s financial records are still the responsibility of the business owner. At the end of the day, you will be liable for any misstatements or misrepresentations.