12.11: Due Diligence

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Professional investors such as angels and VCs, potential employees, and family members use a variety of criteria for evaluating a business plan. The process of evaluating the plan is referred to as due diligence. The Merriam Webster dictionary defines due diligence as:

The care that a reasonable person exercises under the circumstances to avoid harm to other persons or their property;
Research and analysis of a company or organization done in preparation for a business transaction (as a corporate merger or purchase of securities).

Due diligence can be evaluated in terms of how careful investors are in evaluating a business plan and how diligent the founders are in preparing the business plan. There is evidence that when the investor is duly diligent, the business will have a greater chance of succeeding.Applegate et al. (2010). We also believe that due diligence becomes very important as the business emerges from the conceptualization stage and is being built. Due diligence becomes important when the shoe meets the pavement or rather when the entrepreneur starts interacting with the investor. Here are the modified definitions of due diligence:

How wise and careful did the entrepreneur put together the business plan?
How wise and careful did the investor examine the business plan?

We usually read about 20–40 business plans per year. We evaluate the plans in terms of organization and format of the plan, writing, and content. All three areas are interrelated, and it is our experience that hard work usually leads to a great format, good writing, and strong content. Table 12.1 "Due Diligence Checklist Questions Asked by Investors, Founders, and Employees" presents an overview of the major due diligence questions asked by investors, founders, and potential employees. It is one checklist that needs to be checked off. Some of the questions are more important to one group than to another. Just go through them before submitting the final plan. One thing is clear, if the writing style is poor and the plan is poorly organized, then it will be very difficult to sell your ideas. At least 2 or 3 people outside of the founding group should be sought to provide editorial support for the plan format and the content to insure that the plan makes sense.

Table 12.1 Due Diligence Checklist Questions Asked by Investors, Founders, and Employees

	Yes	No	Maybe	NA	Needs Work
Could such a business make money?
Solves a problem or presents unique opportunity?
Is the business concept scalable?
Is the market large and expanding?
Has the target market been adequately identified?
Is the product or service differentiable?
Can customers be acquired at a reasonable cost?
Can customers be locked-in?
Is pricing addressed adequately?
Are current and potential competitors identified?
Addresses competition’s reaction to market entry?
Is the marketing plan adequate and executable?
Is the operation’s plan adequate and executable?
Is the implementation plan adequate/executable?
Are the projected financial statements reasonable?
Can the key management personnel get the job done?
Can the business be built and fulfill promises?
Any hidden traps, oversights, oversimplifications?
Is there contingency planning and risk assessments?