The Tool Desk
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1. Start with suitability and an investment mandate
Due diligence cannot make an unsuitable investment suitable. Define your constraints before reviewing a particular deal so enthusiasm for a founder or product does not change your standards.
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Write down your limits
- Your objective, such as long-term growth, income or strategic exposure.
- Your risk tolerance and maximum tolerable loss.
- When you may need access to the money.
- The stage, sector, geography and check size that fit your mandate.
- The maximum percentage of your investable assets you will place in one private company.
FINRA advises investors to establish goals, risk tolerance and expected liquidity needs before assessing an opportunity’s risks and vulnerabilities. Private-company securities can be highly speculative and difficult to resell; you must be financially able to lose the entire investment.
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Separate an interesting company from a suitable security
A promising business may still be a poor investment at its proposed valuation, with its proposed liquidation preference or with no realistic path to liquidity. Record the return, time horizon and downside you would accept before you see the term sheet.
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2. Verify the company and the offering
Confirm exactly who is issuing what. Do not rely on a slide deck, a social-media profile or a verbal description.
Establish the legal identity
- Obtain the company’s exact legal name, entity type, formation jurisdiction and registration number.
- Confirm the current directors, officers and registered address.
- Identify every intermediary, placement agent or special-purpose vehicle involved.
- Check whether the issuer is raising under a registration, an exemption or another permitted offering route in the relevant jurisdiction.
Request the offering package
Ask for the offering memorandum or equivalent disclosure, subscription or purchase agreement, investor-rights agreement, charter documents, risk factors and any side letters that affect your rights. The documents should identify the security, price, minimum investment, closing conditions, use of proceeds, transfer restrictions and material conflicts.
Check investor eligibility claims
If the offering relies on accredited-investor rules, understand the applicable verification standard. SEC Regulation D guidance says an investor’s unchecked self-certification alone is not sufficient in the circumstances described by the rule; the company must have an appropriate reasonable basis or take reasonable steps to verify eligibility. Ask which standard applies and what evidence the issuer expects.
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Financial diligence is more than reading revenue on a pitch slide. Request primary records and reconcile the story across statements, bank information, tax records and filings where available.
Obtain the core statements
Request a current balance sheet, income statement, cash-flow statement and statement of shareholders’ equity. Ask for the accounting basis, period covered, comparatives and any accountant review or audit. Identify unusual revenue recognition, one-time gains, capitalized costs, related-party transactions and liabilities that do not appear in headline metrics.
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Demand a fully diluted cap table
SEC Small Business Advocacy Office guidance notes that investors will expect a capitalization table that clearly reflects ownership interests. The cap table should list common and preferred shares, options, warrants and convertible notes, together with each holder, class, quantity, issue price and transaction date. It should show the effect of outstanding options, promised grants, notes and other instruments on a fully diluted basis—not merely the founders’ current percentages.
Test the operating numbers
- Compare reported revenue with invoices, contracts, payment records or other evidence permitted by confidentiality rules.
- Analyze gross margin by product or customer, not only the blended figure.
- Review monthly cash burn, accounts payable, debt, taxes owed and contingent liabilities.
- Measure customer concentration and determine whether one renewal or contract drives the forecast.
- Reconcile cash on the balance sheet to bank statements and identify restricted cash.
Record each mismatch as verified, inconsistent, missing or not applicable. A discrepancy is not automatically fraud, but an unexplained discrepancy is a reason to pause.
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4. Model runway, the financing need and use of proceeds
Ask management how much it is raising, why that amount is appropriate and what measurable progress the capital should produce. SEC guidance emphasizes that a raise should reflect runway based on cash burn and projected expenses, with a clear explanation of how proceeds advance the business.
Build your own cash model
- Start with verified cash, committed financing and monthly operating burn.
- Separate recurring operating costs from one-time expenses and capital expenditures.
- Model the proposed raise, fees, taxes and any debt repayment.
- Calculate the month in which cash would fall below the company’s minimum operating reserve.
- Compare that date with the timing of the next expected financing or break-even point.
Stress-test management’s forecast
Run cases for slower sales, lower margins, delayed hiring, higher cloud or production costs, lost customers and a financing round that closes later or at a lower valuation. Ask which spending can be reduced, which commitments cannot be cancelled and whether the company would need emergency financing.
Tie proceeds to milestones
For every major use of proceeds, ask what milestone it should achieve, who owns it and how it will be measured. Examples include a product release, a regulatory approval, a contracted customer target or a specified level of recurring revenue. Ask what happens if the milestone is missed and whether management has a contingency plan.
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5. Validate the market, product, customers and competition
Market-size slides are hypotheses. Your job is to test the assumptions that connect a customer problem to repeatable revenue.
Examine the customer problem and willingness to pay
- Who has the problem, how often it occurs and what the customer does today.
- Who is the economic buyer, user, approver and implementation owner.
- What customers actually pay, how pricing is calculated and whether discounts are temporary.
- How long a sale takes, what causes deals to stall and what implementation requires.
- Retention, expansion, churn and cohort behavior by customer start date.
Where confidentiality permits, speak with customers or obtain independently verifiable references. Distinguish signed contracts from pilots, letters of intent, unpaid trials and management’s sales pipeline.
Challenge the market-size calculation
Rebuild the addressable market from identifiable customers, realistic pricing and a plausible distribution capacity. Ask which geography, industry definition and time period the estimate uses. A large theoretical market does not establish that the company can reach it profitably.
Map competitors and substitutes
List direct competitors, internal workarounds and adjacent products. Compare price, implementation burden, switching costs, distribution access, retention and regulatory barriers. If management claims a moat, ask what prevents a well-funded incumbent or a customer from reproducing the feature. UK government investor-readiness guidance highlights market opportunity, customers, competitive advantage, traction, team capability, governance and sector conditions as areas investors scrutinize.
6. Investigate founders and the team
The people running a young company often represent a larger risk than any single forecast line.
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Verify background and commitment
- Confirm identity, employment history, education and professional credentials independently.
- Contact references who can describe performance, judgment and integrity.
- Check prior ventures, exits, failures, bankruptcies, litigation and regulatory sanctions.
- Identify conflicts of interest, undisclosed related parties and other board or operating commitments.
- Confirm who is working full time and what conditions would cause a founder to leave.
Investor.gov advises checking the people promoting an investment even when they are personally known to you. Familiarity is not verification.
Review incentives and succession
Read employment agreements, invention-assignment provisions, compensation arrangements, option plans and vesting schedules. Identify key-person exposure: which relationships, technical knowledge or approvals would be difficult to replace? Ask who can operate the company if a founder becomes unavailable and whether the board has a succession process.
7. Complete legal, intellectual-property, privacy and regulatory review
Use qualified counsel for issues outside your expertise. A legal defect can reduce value or prevent a transaction even when the product is strong.
Corporate and commercial records
- Formation documents, amendments, board and shareholder minutes, written consents and delegated authorities.
- Material customer, supplier, distribution, partnership and employment contracts.
- Debt instruments, liens, security interests, guarantees, leases and insurance coverage.
- Pending, threatened or settled litigation, investigations and regulatory notices.
Intellectual property and technology
Confirm that the company owns or has valid licenses for patents, trademarks, copyrights, domain names, source code and data it relies on. Check founder and employee invention assignments, contractor agreements, joint-development terms and open-source compliance. Look for obligations that require source-code disclosure, restrict commercialization or give a former employer rights to the technology.
Data and sector obligations
Review privacy notices, data-processing agreements, cybersecurity controls, breach history, retention practices and cross-border data transfers. Verify licenses, permits and sector-specific approvals. Ask whether customer contracts require security certifications or impose indemnities that the company cannot afford.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.8. Read the security terms and model future financing
The same company can produce very different outcomes for investors depending on the instrument and rights attached to it.
| Term to examine | Question to answer |
|---|---|
| Liquidation preference | Who gets paid first, at what multiple and before which holders? |
| Participation | Can a preferred holder receive its preference and then share in the remaining proceeds? |
| Conversion | When can the security convert, and is conversion automatic in a qualifying financing or exit? |
| Anti-dilution | What happens in a down round, and which formula applies? |
| Dividends and redemption | Are payments cumulative, discretionary or capable of forcing a company repurchase? |
| Voting and consent | Which actions require this class’s approval? |
| Information and pro-rata rights | What reporting will you receive, and can you maintain your ownership in later rounds? |
| Transfer, drag and tag provisions | Can you sell, be required to sell, or join a sale on the same terms? |
| Side letters | Do other investors have rights or preferences that you do not have? |
Model dilution, not just today’s percentage
Recalculate ownership after an option-pool increase, convertible-note conversion, a new preferred round, a down round and a sale. Include the price and conversion mechanics of every outstanding instrument. Ask whether the proposed valuation is pre-money or post-money and who bears the dilution from a new option pool.
Assess liquidity honestly
Private securities may have no active resale market. Identify contractual transfer restrictions, company repurchase rights and any plausible exit paths. Do not treat a hoped-for acquisition or future secondary sale as guaranteed liquidity.
9. Screen for fraud and process red flags
Investor.gov warns that fraudsters count on people failing to investigate before investing. Pause and independently verify when you see:
- Unlicensed professionals or an intermediary whose registration cannot be confirmed.
- Exaggerated credentials, unverifiable awards or claims of guaranteed or risk-free returns.
- Pressure to invest immediately, secrecy about ordinary documents or refusal to allow professional review.
- Sensational testimonials, unsolicited messages or company news used as the sole basis for a decision.
- Requests for personal data before the issuer’s identity and purpose are established.
- Payment by credit card, gift card, an overseas wire or an account in an individual’s name rather than the documented issuer or escrow arrangement.
One red flag warrants a pause and independent verification. Multiple unresolved red flags should stop the investment until the facts are explained and documented.
10. Run a documented diligence process and set decision gates
A disciplined process prevents the most persuasive person in the room from becoming the de facto investment committee.
- Create a request list covering corporate, financial, tax, commercial, people, IP, privacy, regulatory and financing records.
- Index the data room and record the date and version of every document received.
- Assign an owner to each question and mark the result verified, inconsistent, missing or not applicable.
- Reconcile management’s claims with primary records and note the evidence supporting each material assumption.
- Ask management to explain discrepancies in writing and preserve both the question and response.
- Have legal, tax, accounting and financial professionals review matters beyond your expertise.
- Translate material findings into conditions precedent, revised valuation, changed terms, escrow, indemnity or governance rights.
- Approve the investment only when the remaining open items fit your risk limit and are explicitly accepted.
A practical document request list
| Area | Documents or evidence |
|---|---|
| Company and offering | Formation records, offering memorandum, subscription agreement, investor-rights documents and risk disclosures |
| Finance | Balance sheet, income statement, cash-flow statement, shareholders’ equity statement, budgets, bank evidence and debt schedule |
| Ownership | Fully diluted cap table, option and warrant schedules, convertible instruments and prior financing documents |
| Business | Customer contracts, pipeline definitions, retention and cohort data, pricing, supplier agreements and market assumptions |
| People | Founder biographies, employment and invention-assignment agreements, compensation, vesting and references |
| Legal and technology | Material contracts, litigation schedule, IP registrations and assignments, licenses, open-source review and insurance |
| Data and regulation | Privacy policies, security materials, breach history, permits, licenses and sector compliance records |
How to compare two opportunities
Compare opportunities on evidence quality, not presentation quality. Use the same questions and scoring definitions for each company.
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| Comparison axis | What to compare |
|---|---|
| Verification access | Completeness of records, quality of primary evidence and willingness to answer questions |
| Market and customers | Market assumptions, customer proof, sales cycle, retention and concentration |
| Economics | Growth, margins, burn, runway and dependence on another financing |
| Team | Capability, references, time commitment, key-person and succession risk |
| Exposure | IP ownership, privacy, regulatory obligations, litigation and contractual liabilities |
| Price and dilution | Valuation, option-pool treatment, conversion mechanics and future-round scenarios |
| Downside protection | Liquidation, voting, information, pro-rata and transfer rights |
| Liquidity | Transfer restrictions and credible exit paths |
| Open issues | Number, severity and reversibility of unresolved diligence items |
Important limits
This framework is general information, not individualized investment, legal, tax or accounting advice. Offering rules and investor-eligibility requirements vary by jurisdiction and can change. Use current filings and transaction documents, and obtain advice tailored to the specific issuer, security and investor.
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