Get All Access for $5/mo

Deal or No Deal? Here Are 7 Ways Due Diligence Can Help Before a Final Commitment. Due diligence might sound daunting, but it's really just an in-depth common-sense risk analysis before closing a business deal.

By Martin Zwilling

Opinions expressed by Entrepreneur contributors are their own.

Deal or No Deal | NBC

Most entrepreneurs work long and hard to get a handshake agreement from an investor, and then tend to relax and wait for the check to clear. What they don't realize is that about half the investment deals fail to close at this stage, including mergers and acquisitions, during the due-diligence process. The same is true of Dragon's Den and Shark Tank investments you see on TV.

Remember that investors at this stage have heard primarily from the founder, and only reviewed written business plans and collateral. Due diligence is going the next step, to meet and interview all key members of the team, visit the business location and follow-up with early customers and advisors. Everyone expects a few flaws, but serious undisclosed issues will likely kill the deal.

Related: 3 Sales Secrets I Learned From Interrogating Criminals

For entrepreneurs, due diligence may seem like a mysterious process, with secret formulas and tricky questions, to give investors leverage. In fact, it's really just an in-depth common-sense analysis of key success parameters of any startup to assess the risk before final commitment. Here are seven key elements of the business that are typically included in the evaluation.

1. Team synergies, commitment and depth

A dysfunctional team will jeopardize even the best of plans. A smart investor will normally interview all key team members and look for evidence of commitment to the same goals, depth of skills and experience and respect for all constituents. Undisclosed skill gaps or agendas can stall your investment.

Related: Looking for a New Payment Company? You're 'Due' for Some Good News.

2. Customer and market interaction

Investors will test your relationship with real customers, based on the data you provide. Existing and potential customers echoing your passion can be your best support, while no customer interaction or interest can likewise be a huge negative. It's smart to contact and prep all customers before investors call.

3. Solution readiness and quality

This element is usually called technical due diligence and typically consists of a day with your engineering and marketing team led by internal team leaders. This is really an assessment of the team and internal processes as well as the product. Related discussions include intellectual property status and plans.

4. Competitive positioning and barriers to entry

For this element, investors normally look for an outside expert to validate your analysis of competitors and positioning. Again, you need to head off any surprises by making sure you have mentioned all key competitors and thoroughly prepped the investor team on your strategy and direction.

Related: 7 Reasons Why 'Just Ask' Is the Best Negotiation Tactic

5. Business structure and financial risks

Be prepared to present a detailed cap table, identifying by percentage all owners, investors and debtors. Any unusual financial risks, including contingencies, large contracts, recent bankruptcies or credit denials on the part of any owners must be disclosed. The business structure should be clear and simple.

6. Track record of setting and meeting milestones

Investors have found that results to-date in a startup are very indicative of future results. Entrepreneurs who set milestones for their team, and consistently meet or exceed the commitments are much more likely to do the same with invested funds. No milestones set or most not met is a huge red flag.

7. Skeletons in the closet

No investor likes to be surprised in their due diligence by non-disclosed individual or startup tax problems, regulatory issues or negative publicity, either currently or in the last five years. Your best defense to any negative is early full disclosure, followed by a credible explanation, no excuses and many positives since.

Based on my own experience as an angel investor, I'm convinced that surprises rarely are any intent by the entrepreneur to defraud or even mislead potential investors. More often, it's simply an innocent lack of disclosure of current relationship and operational issues which could raise investor qualms about the health of the business, despite a huge opportunity and a great product.

The best entrepreneur strategy for due diligence is to be as open and transparent as possible. Current issues and shortcomings should be disclosed in the most positive way to investors, before issues are exposed as surprises during the diligence process. Even one negative surprise implies others waiting to be found and will kill your integrity as well as sour the deal.

It's always fair to ask the comparable questions of an investor to avoid surprises in that direction. Taking on an investor for a startup is a long-term partnership or marriage, so both sides need the same level of trust and commitment. It's nice to start with a little mystery in a relationship, but neither side likes surprises during the honeymoon or later.

Related: 4 Ways for Any Business Pro to Close the Deal

Martin Zwilling

Veteran startup mentor, executive, blogger, author, tech professional, and Angel investor.

Martin Zwilling is the founder and CEO of Startup Professionals, a company that provides products and services to startup founders and small business owners. The author of Do You Have What It Takes to Be an Entrepreneur? and Attracting an Angel, he writes a daily blog for entrepreneurs and dispenses advice on the subject of startups.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Science & Technology

How Generative AI Is Revolutionizing the Travel Industry

GenAI won't displace travel agents; instead, it will enhance their efficiency, enabling them to focus on crafting tailored experiences that resonate with travelers on a deeper level.

Business News

Mark Cuban's Google Account Was Hacked By 'Sophisticated' Bad Actors

The "Shark Tank" star said someone "called and said I had an intruder and spoofed [Google's] recovery methods."

Business News

Target Teams Up With Shopify To Give Online Small Businesses Brick-and-Mortar Shelf Space

Target has an online Amazon competitor marketplace, and it's taking applications from small businesses now.

Starting a Business

5 Steps to Move Beyond Small Talk and Start the Business You've Always Dreamed of

Make your business idea a reality by following these five no-nonsense steps.

Business Ideas

63 Small Business Ideas to Start in 2024

We put together a list of the best, most profitable small business ideas for entrepreneurs to pursue in 2024.

Business Solutions

Set Your PC-Using Employees Up with Windows 11 Pro for $25

This updated operating system features top-of-the-line security, AI support, and more.