Occasionally, early investors will send extensive seed round due diligence requests to a startup way too early. By way too early, I mean when a potential investor sends your startup an 8+ page seed round due diligence request list– without having made any sort of “commitment” to invest. This transmission of a “too early” seed round due diligence list is problematic for a number of reasons.

Time is Money (and likely money you don’t have yet)

First, the early due diligence process could be a waste of your startup’s time and money. If the potential 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) in response to a seed round due diligence production request ends up being a complete loss.  Why risk both time and money if the potential investor has not even made a soft commitment to invest in your startup?

You could be working on closing deals..or other investors

Second, responding to an extensive seed round due diligence list early (without any sort of commitment) can put your startup at a standstill. It will likely take a good chunk of your startup’s personnel to prepare the seed round due diligence, which puts a halt on development of your startup’s product and/or service.  You could risk taking people off your development projects for a small period of time and for what?

Also, the request for due diligence might give your startup a false positive, by interpreting the seed round due diligence request as a commitment. Then you could end up focusing on this one particular investor. And, unfortunately, when the seed 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.

Too much information (TMI)

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, intellectual property 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.). Be prudent about what you send across.  One mistake I see startups make is they send the kitchen sink to each potential investor (sometimes without a signal from the seed investor that they are interested in investing).

Conclusion

Due diligence is a process that benefits both seed investors and startups. A startup can learn about a potential investor by the diligence requests and associated questions. But your startup shouldn’t enter into an extensive seed round due diligence phase without some sort of commitment by the potential investor. Sure, a term sheet is a sign of commitment, but a seed investor should be able to demonstrate commitment prior to a term sheet, especially if they are asking for more than nominal diligence about your startup.

---

ACCELERATE YOUR STARTUP LAW KNOWLEDGE!

Startup Law doesn’t have to be a confusing maze. The practical knowledge in "Acceleration: What All Entrepreneurs Must Know About Startup Law" will help you make the smart decisions to protect your startup and its future. Available in ebook and hardcover.

Buy the Book on Amazon