Diligence and preparation vital to secure investor funds

Many small businesses will require outside capital to expand operations, to grow a market or to develop new products. These funds can come from several sources, including the entrepreneur's own resources, friends and family, banks, angel investors and venture capitalists.

The initial founding of the company will often drain the entrepreneur's own money as well as his or her family resources. Banks may be hesitant to lend money when a company has few assets and little operating history, leaving the business owner in the position of needing to raise money from professional investors.

When approaching angel investors or venture capitalists, one is expected to have developed a business plan and formal presentation that will address the company, product, market, competition, management team and financial situation, including the amount of money needed and how it will be used. A quality business plan and presentation can take hours and sometimes days to develop, and it usually leaves the entrepreneur feeling that he/she is now ready to raise the funds. But in fact, the process has just begun, as several more weeks of due diligence are now ahead of the company.

A friend of mine is currently raising venture funds to expand his business and market reach. He initially developed an excellent plan and visual presentation and then went on a "road show," communicating his opportunity to venture capitalists in both this region of the country and on the west coast. After finding an interested party, he signed a term sheet outlining the structure of the relationship: the amount of funding, the pre-money valuation of his company, dilution, board control, type of security and other issues.

The term sheet was signed last fall; he is still in due diligence and hopes to close the investment round this month. The due diligence has taken several months and has drained much more time from his schedule than developing the initial plan. Due diligence can be overwhelming to a small organization and often leads to a separation between the investor and the entrepreneur, both of whom were once excited about working together.

In "Venture Capital Due Diligence," Justin Camp defines diligence as "the thorough investigation and analysis the investor makes of a prospective investment to see if it meets the investor's strategy and criteria for funding. It includes an assessment of the industry, market, business concept, management team, the company's technology, products and markets and financials."