M&A due diligence for startups: An overview

About 16% of startups end up getting acquired, according to TechCrunch. For founders who are considering selling their startups, we’ve got an in-depth guide to selling your company.

If your startup is ready to begin the merger and acquisition (M&A) process, you need to understand due diligence to make sure your company makes a successful transition.

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Due diligence is a comprehensive investigation of a target company’s financial, legal, and operational aspects to assess its value, risks, and potential synergies. Here’s what you need to know about navigating this critical phase.

The importance of due diligence

Due diligence serves several key purposes in the M&A process, including:

  • Verifying the target company’s financial health and performance
  • Identifying potential risks and liabilities
  • Assessing the strategic fit between the companies
  • Providing information for valuation and deal structure decisions
  • Preparing for post-merger integration

Since startups have a limited operating history, acquiring companies rely on thorough due diligence to uncover issues that may not be readily apparent.

Key components of due diligence

Due diligence typically covers three broad areas: financial, legal, and operational due diligence. Let’s take a look at each of these areas.

Financial due diligence

This involves a detailed examination of the target company’s financial statements, accounting practices, and projections. Key areas of focus include:

For startups, acquiring companies pay particular attention to the sustainability of growth rates, customer acquisition costs, and burn rate. Financial due diligence is a complex process, and you should review our detailed guide to financial diligence. If you want to know what items may be requested during financial due diligence, you can download our checklists. Of course, we recommend that you work with an experienced finance and accounting team like the team at Kruze - clients we work with are twice as likely to be acquired as the typical, funded startup. Learn more about how we help startups succeed - in M&A and beyond.

Legal due diligence aims to identify any legal risks or liabilities. Every startup should work with an attorney with extensive startup experience, which will help with the legal diligence process. Legal diligence includes reviewing:

  • Corporate governance documents
  • Material contracts and agreements
  • Intellectual property rights and protections
  • Pending or potential litigation
  • Regulatory compliance

Startups should also be prepared to provide documentation on equity structures, including stock option plans and investor agreements. For more information on what may be requested during legal diligence, you can review and download our checklists.

Operational due diligence

This aspect examines the target company’s business operations, including:

  • Product or service offerings
  • Customer base and relationships
  • Supply chain and vendor agreements
  • Technology infrastructure
  • Human resources and organizational structure

For tech startups, assessing the scalability of the technology platform and the strength of the development team is particularly important.

The due diligence process

The due diligence process can take anywhere from a few weeks to several months, depending on the complexity of your startup and the scope of the acquiring company’s review. Generally speaking, due diligence for early-stage startups takes less time than diligence for later-stage companies. The steps in the process include:

  1. Preparation. The acquirer prepares a due diligence checklist outlining required information and documents.
  2. Data collection. The target company gathers and organizes the requested information, often in a virtual data room.
  3. Review and analysis. The acquirer’s team, including accountants, lawyers, and industry experts, examines the provided materials.
  4. Inquiry and clarification. Follow-up questions are asked to clarify any issues or gaps in information.
  5. Reporting. Findings are summarized in a due diligence report, highlighting key insights and potential deal-breakers.
  6. Negotiation. The results of the due diligence will factor into final negotiations on deal terms and price.

Tips for startups undergoing due diligence

Remember that the acquiring company will have many questions about your startup, and you’ll need to provide comprehensive, data-based answers that show your deep understanding of your business and your market.

  1. Be prepared. Organize your financial, legal, and operational documents well in advance in a secure data repository.
  2. Maintain transparency. Disclose potential issues proactively to build trust with the acquirer.
  3. Engage experts. Work with experienced accountants and lawyers who understand the unique challenges of startup M&A.
  4. Protect sensitive information. Use staged disclosure and confidentiality agreements to safeguard proprietary data.
  5. Stay focused on your company. Designate a due diligence team to manage the process while others maintain your business continuity.

Work with Kruze

As your accounting partner, we’re here to guide you through every step of the due diligence process, to make sure that your financial information is accurately presented and that you’re prepared for the scrutiny M&A brings. Our expertise in startup financials allows us to highlight your company’s strengths while addressing any potential concerns proactively

NOTE: All parties to any financing agreement should consult with their legal counsel and accounting advisors for specific due diligence requirements related to their individual circumstances, investing goals, and business requirements.