We are seeing several new trends in the due diligence that venture capitalists do prior to completing a deal. Kruze is in a unique position to notice new venture capital trends since Our clients have raised over $10 billion in early-stage funding. Here are the trends that matter most to early-stage companies looking to fund raise in 2020.
2020 Venture Capital Due Diligence Trends
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Outsourced diligence - The biggest funds are now outsourcing their financial and tax due diligence to “Big 4” accounting firms like PricewaterhouseCoopers. The partners at these big accounting firms seem to REALLY want to do business with the VCs, and we’ve seemed senior accounting professionals from the Big 4 turning what should be easy diligence calls into serious accounting discussions. Because these are accountants, they are asking detailed accounting and tax compliance questions. Stuff most startup founders shouldn’t be expected to know! It’s legit finance due diligence. We strongly suggest you have your books and taxes in order prior to beginning a fund raise.
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FAST diligence - the best VCs are starting to move incredibly quickly. Josh Kopelman of First Round Capital recently mentioned the time from the first conversation to term sheet has shrunk from 90 days in 2014 to nine days. That’s really fast. The best founders that we work with are ready on day 1 of their fundraising process and have their due diligence materials in a Box, Google Drive, Dropbox, etc. folder ready to share. Check out our VC finance, accounting and tax due diligence checklist (free to download).
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Unit economics are starting to matter more - fallout from WeWork continues to work its way down through the funding stages. Early-stage VCs are spending more time trying to understand unprofitable startups’ margins once they reach scale. We are still seeing low to negative gross margin companies get funding; however, these companies all have a clearly articulated path to great margins.
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NOLs and tax credits are coming up during diligence - this is directly related to the top venture firms hiring Big 4 accounting firms to do diligence. The good news is that unprofitable startups can use tax credits to cut their burn rate; the bad news is that if you don’t take the election you probably lose it. These accounting firm partners are looking for detailed documentation on your R&D tax credits. If you don’t know much about this, you can read more about R&D tax credits for startups.
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Backup on the books - again, related to real accountants getting hired to run diligence. The Big 4 firms like to see solid documentation in your accounting systems. If you are doing your startup’s books yourself, make sure you are carefully attaching the invoices, receipts, etc. onto each transaction. Be very, very carefully documenting any “related party” transactions, like loans or investments from the founders into the business. And don’t mess up your revenue recognition. Or, outsource your bookkeeping to someone like us for a pretty affordable monthly cost.
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Early-stage VCs are asking about “Total Capital” required to reach exit/breakeven - this is something early-stage investors usually ask about, but we are seeing more scrutiny on financial projections and the amount of cash startups are saying they will need to get to an exit. Make sure you have a well developed financial model and are ready to explain how many rounds of funding you will need to develop your business. We have some financial models you can download if you are looking for templates.
We’ll update this post if we see other trends in 2020!
