Seeking funding is a major part of the entrepreneurship journey.
If you’ve got big ambitions for your company, it’s one of the most important activities you’ll pursue as an Eastern Kentucky business owner. Funding can be the catalyst that takes you from running a local business to operating on a larger scale.
In order to get funding, you’ll have to pitch your business plan to investors or banks. But just having a good business plan won’t convince them to help you grow your idea.
You’ll also need to be able to prove product-market fit before approaching investors.
It’s not enough that you think you have a great idea for a product or service. You’re not even guaranteed success if your family and friends are fans, too. There has to be a strong need or want in the market for what you have to offer.
This demand is called product-market fit.
And you must prove you have it — even in the most basic form — before you seek funding. Investors will look for a strong business plan and product-market fit during the due diligence stage.
Once you have these tasks completed, you’re ready to move forward.
However, before you jump into the process, it’s important to understand what due diligence is, how it works, and what responsibilities you have to your potential funders.
What is due diligence?
Due diligence is an investigation of a company’s worthiness to receive an investment, loan, or grant.
Investors, banks, and grant organizations perform due diligence to evaluate an organization’s financial standing, business plan, and potential for success.
The due diligence team includes an attorney and an accountant:
- The attorney will analyze the potential for legal problems after an investment, such as a lawsuit.
- The accountant will go through financial statements with a fine-tooth comb to rule out errors or deceptive practices.
Funders perform due diligence because they need to know they can rely on the organization and its leadership to handle the funds legally and effectively.
In the case of investors, they’ll evaluate the potential impact on their bottom line — they have to be confident they’ll earn a positive return on their investment.
Bank lenders have an obligation to issue loans to businesses they believe will be capable of paying back the entire principal plus interest.
And grant organizations want to see their grantees succeed — which they determine by reviewing your well-thought-out plan based on facts, research, and expertise.
How due diligence works
Due diligence has two sides: the business owner and the funder. Each has a specific role to play in the process.
Obligations of the business owner
As the potential recipient of an investment, grant, or loan, it’s your job to open up the hood of the car and show your funding partner how everything currently works.
You must disclose your complete financial and legal records, including:
- A current budget
- Cash flow statements
- An account of business assets
- Company debts
- Contracts with other parties
- Patents and provisional patents
- Conflicts of interest
- Outstanding lawsuits or impending legal action
A lot of these items will be included in your business plan. If yours doesn’t — or you don’t have one — the SOAR Innovation team provides this as a complimentary service to entrepreneurs in Eastern Kentucky.
Prepare to hand over in-depth documentation to fulfill your funder’s needs. And if you have the chance to provide independently audited records, that’ll build more credibility.
The process will also call for presentations to your funders.
These discussions will focus on your strategy, business projections, and plans. Prepare for interviews, meetings, and plenty of face-time with the due diligence team.
Obligations of the funder
The funder will do what’s best for their bottom line. Whether that’s earning a positive ROI or complying with legal requirements, they use the due diligence process to evaluate an organization and its leadership thoroughly.
Finders will spend this time asking in-depth questions and following up to verify your answers.
You can expect them to examine everything you provide them under a microscope.
Why you need to prepare for due diligence now
Preparing for due diligence isn’t something you can get done in a day — or even a week. It requires you to have solid, trackable systems in place well before starting the process.
If you prepare for due diligence now, you can expect a smoother experience for your funders and yourself from start to finish.
When you look at what funders need to evaluate, you’ll see plenty of overlap with existing best practices for operating an effective business.
This includes maintaining:
- Automated accounting systems, including tax records, payroll, and accounts payable/receivable ledgers.
- Up-to-date financial systems, including a budget, cash flow, and projection documentation.
- Well-documented strategy, staffing plan, and expected outcomes.
If you start these now, you’ll be putting yourself in a stronger position for due diligence — and be equipping yourself with essential resources to power your business forward.
How to prepare for due diligence
Step 1: Build scalable financial and accounting systems
QBO’s reports feature makes it easy to provide exactly what most funders will ask for during due diligence. Since you set up the software to house all of your financial and accounting information, accessing the documents funders require will be as easy as a few clicks.
Step 2: Make sure your due diligence documentation is readily available
Onboarding financial and accounting software is a great start. But you have to keep your records up-to-date for your reports to be accurate and relevant.
Staying organized and maintaining accurate records will ensure your due diligence documentation is ready for review at any given moment.
There are plenty of opportunities to leverage QBO to automate some of this work for you. Leverage it to the fullest extent possible, and then it’s one less thing to worry about.
Step 3: Be open and willing to participate in the process
Funders will require a lot of your time and energy while they conduct due diligence.
If you can, find a way to delegate some or most of your responsibilities to trusted staff during this period.
Be prepared to give a lot of your time to this process. Start on the right foot by fully committing yourself and focusing on building a strong relationship with the people involved.
Remain open, honest, and transparent from beginning to end — it will go a long way towards establishing trust with your potential funders.
Step 4: Conduct reverse due diligence
As your funder or lender evaluates your capabilities, you’ll also want to make sure they can follow through on their promises.
In the case of investors, ensuring you have a good relationship will be critical. If they’re going to be involved in your business, especially as equity partners, having good chemistry and well-aligned philosophies will facilitate a strong partnership.
Make sure your funder has a good reputation, too.
Check out reviews and testimonials from organizations that have worked with them. You’ll want to ascertain they’ve made good on their promises to businesses like yours in the past.
Conclusion: Access more resources for Eastern Kentucky entrepreneurs
SOAR Innovation — powered by Kentucky Innovation — is Eastern Kentucky’s go-to resource for entrepreneurs. We work with small business owners to support their success at every stage of business ownership.
Due diligence is just one of many critical activities for growing organizations.
Check out the Complete Guide to Entrepreneurship in Eastern Kentucky for additional tips and resources on launching, growing, and optimizing your business.