Occasionally, angel investors will send extensive due diligence requests to a startup way too early. By way too early, I mean an angel investor sends your startup an 8+ page due diligence request — without having made any sort of “commitment” to invest. This is problematic for a number of reasons.
First, this could be a waste of your startup’s time and money. If the angel investor is just fishing rather than actually reeling you in, all the time and money spent preparing the answers and documents (including any associated attorney time) for an extensive due diligence production ends up being a complete loss.
Second, this can put your startup at a standstill. At the time of an angel investment, a good chunk of your startup’s personnel will be active in preparing this due diligence, which puts a halt on development of your startup’s product and/or service.
Third, some of the diligence requests may involve information that you may not want to divulge at such an early juncture. This information could be of a confidential nature, IP or trade secrets, or customer lists and contacts. You don’t have to send a detailed cap table to someone just ‘fishing’ — worst case send them a cap table summary which lumps groups of people together (founders, optionholders, convertible debtholders, etc.).
Finally, the request for due diligence might give your startup a false positive, by interpreting the due diligence request as a commitment. Then you focusing on one particular investor. And, unfortunately, when the angel investor ends up not investing, your startup will be left with no investor momentum, a lost couple of weeks, and maybe a small legal bill.
Due diligence is a process that benefits both angel investors and startups. A startup can learn about a potential investor by the diligence requests and associated questions. But you shouldn’t enter into an extensive due diligence phase without some sort of commitment by the angel investor. Sure, a term sheet is a sign of commitment, but an angel investor should be able to demonstrate commitment prior to a term sheet.