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the investment process

The investment process typically goes through several common stages which willd describe in more detail below:

• Sourcing
• Evaluation (triage)
• Due Diligence
• Initial Approval
• Term Sheet
• Negotiation
• Final Approval
• Legal Documents
• Wiring Money

Sourcing

Sourcing is the term that investors use for the process of finding a new deal.  Investment professionals like venture capitalists or firms like venture capital firms are constantly looking for new great deals, or investments.  Investment professionals will typically source, or find, deals through their own personal networks, referrals from trusted business partners or advisors, or through direct contact from somebody looking for money.

Evaluation (triage)

Afer finding a new deal, the investment professional will begin to evaluate the deal.  Most investors will bucket the deal into one of several categories:

• Pass.  These are deals that they will not invest in so they will typically "pass" on the opportunity to invest.  Generally the investor will communicate the bad news to the entrepreneur through some kind of polite notice.
• Active due diligence.  These are deals that have a high likelihood of working out.  The investor will generally move into some form of due diligence quickly.
• Evaluate.  These are deals where it isn't clear whether or not the investor should pass or move to active due diligence.  They often require some level of diligence just to understand whether or not they represent great opportunities for investment.  However, given that there is a high risk that the deals may not ultimately matriculate, due diligence is often performed as the investor has time to do it

Due diligence

If the investor decides that there is some likelihood that she or her firm may want to fund the deal, they will generally begin some preliminary due diligence.  This due diligence will continue throughout the investment process until the money is wired and beyond.  However, the majority of the due diligence will be performed prior to closing the deal which is defined as reaching a contractual legal agreement to invest money into the new venture.  Most investors will stage due diligence where the cost and time dedicated to due diligence increases as the investor gets closer and closer to approving the investment.  The following is a common approach to staged due diligence:

• 1 Day.  An investor will often spend one day on  due diligence for a company that has some promise but he or she is not clear that it will ultimately pass.
• 1 Week.  Assuming that the investment opportunity passed the 1 day diligence process and the investor is still interested, he or she will move toward 1 week of due diligence.
• 1 Month.  Assuming that the investment opportunity passed the 1 week diligence process and the investor is still interested, he or she will move toward 1 month of due diligence after which the investor will generally close the deal.

Different firms have different names for the stages of diligence and different timing.  For example, some firms may take up to 3 months for the full due diligence process but this provides a good high-level model of a typical system. 

As part of the due diligence process, a company will generally visit the firm during a partner meeting so that the full partnership can meet and assess the management team of the company.

Initial Approval

In a firm setting, where the investor evaluating the deal is one of several partners, he or she will generally need to secure partner approval before investing in the deal.  Some firms are stuctured so that a deal is approved when a majority of partners vote to approve a deal.  Others are structured so that a deal is approved only when the partners unanimously support approving the deal.  In any case, approval in partnerships will require broader support.  As a side note, most partnerships refer to the partner who is leading the firm's due diligence effort on a particular company as the "lead partner" for that deal. 

If the lead partner has successfully completed a significant amount of due diligence, he or she will ask the partnership (the other voting partners) for approval to issue a term sheet. This is a major milestone in the investment process because most firms close deals after issuing a term sheet.  While technically the term sheet explicitly calls out the ability for the investor to back out of a deal upon any negative due diligence findings, most investors do not grant term sheet unless they think that they are doing to fund the company.

Term Sheet

The term sheet is a relatively short document that specifies the terms of a proposed investment.  It is intended to acclerate the deal process, focus the parties on key issues for negotiation, and indicate a level of committment from both parties.  While you can see a full discussion of term sheet terms on our term sheet page, terms can be categorized into two super-categories:

• Valuation
• All other terms

The valuation establishes what the company is worth and is directly related to the concept of entrepreneur dilution.  The higher the valuation, the less dilution the entrepreneur will suffer.  The lower the valuation, the more dilution the entrepreneur will suffer.  By putting all of the other terms into one category, we do not intend to deemphasize their importance but rather to emphasize the importance of valuation.  There tend to be standards and widely accepted norms for the other terms.  Violation of a norm in one term usually comes with a trade-off in another term.  Also, it is our belief that for the most part investors who are excited enough to do a deal (at least in first-time investments) will generally not ask for crazy terms.

Negotiation

Negotiation can add a significant amount of time to the process.  This is the period where the investor(s) and the entreperneur(s) debate various terms and conditions of the financing.  Again our term sheet page, has a broader discussion of these terms. 

Final Approval

When the lead investor(s) and the enterpreneur(s) have come to final terms, the lead investor(s) will return to his or her partnership to secure final approval for funding the deal.  In most firms this occurs during partner meeting. 

Legal Documents

After final approval, the investor's(s') counsel and the company's counsel will begin to draft and negotiate final legal documents for the investment.  This process can take up to one month or longer but it can also be finished in a few weeks. 

Wiring the Money

Coincident with the signing of the legal documents by both parties (the investor(s) and the company), the investor(s) will wire money into the company's account or make funding available if the funding is a credit line.  This finalizes the investment process.