Expect potential investors to ask tough questions

A few years ago, I traveled with a young founder to Dallas for a series of meetings with investors. At the end of the first day, the entrepreneur suggested that he was finished answering questions and that he just wanted to return home to run his business.

He found the investors to be overbearing and concluded that the meetings had been negative and unproductive.

My impression was different. The investors, some of whom had invested in the industry on other occasions, were well informed and pointed out several areas in the entrepreneur's business plan where improvements could be made. They had been critical of many of the assumptions in the plan and were legitimately concerned about his team and plan of execution.

I was energized by the day's events; he was discouraged. The questions led me to believe that the business model was close to being right; he was offended because they did not buy into his assumptions. We talked and decided to go back for another day of meetings — this time with a different attitude on his part. The rest of the story is that he did launch the company and has seen some success, and we were both enriched by the due-diligence process.

Due diligence is the art (and the science) of studying a company and its business plan with the intended objective of making an investment in the enterprise. Depending upon the attitude and disposition of the entrepreneur, it can be an intrusive and difficult process or a great learning experience, leading to a new understanding of one's company.

The following is a synopsis of what one might expect during due diligence with investors:

• The management team: Most investors will tell you that they want to know the management team. Expect the investors to call your references and to find and contact blind references. A typical question when speaking to a management referral is to ask that person who else the investor should contact. Many investors will try to triangulate their assessment of the team based upon three perspectives: would the investors like to work with the management team, is the team honest and believable, and has it executed successfully in the past.

• The customers and the market: Your customers and potential customers will be contacted directly. For pre-revenue companies, the questions will revolve around the product concept or prototype — what problem will it solve, how important is this problem to the customer and how much would someone pay for it. Companies with existing customers can expect investors to ask how the product is satisfying needs, the level of quality and whether the customer service is meeting post-sale expectations.