Investor due diligence: The African tech startup founder's guide
May 16, 2024
Adam Wakefield
Navigating investor due diligence as an African tech founder.

The future of your tech startup hangs by a thread as you stand before a room of stone-faced investors. Your innovative idea could shake up the industry - if only you can convince them. They're interested, but before committing their venture capital, they must thoroughly understand every aspect of your business. This is where investor due diligence (DD) can be a game-changer. 

Since 2023, DD has taken on increased significance as the African tech ecosystem experiences a slowdown in investment activity. Tougher economic conditions are leading many investors to dedicate more time and resources toward DD in the ecosystem to protect their potential investments. If you are a founder who has never been through a DD process nor has high-level knowledge of what such a process entails, stepping into the unfamiliar can be highly unsettling.

Keep reading to have all your due diligence questions answered and impress investors to receive that much-needed venture capital.

What is investor due diligence? 

The investor due diligence process is the ultimate test for startups, where venture capitalists put your company under the microscope. They're looking at your business's financial health, track record, adherence to laws, how well it operates, how it manages potential risks, and its capability to conquer the market. The journey starts with screening, as VCs filter through many companies to spot the ones that match their investment scrutiny. Next up, they look closely at your team, product, and how your business plans to make money. The final hurdle? A legal review to ensure everything's up to code.

For founders across Africa, acing this test doesn't just mean securing funding — it's about aligning your vision with those who can help make it a reality, setting the stage for your startup's success story.

Understanding investor due diligence

In the due diligence phase, investors dive deep to verify the details of your startup. This crucial step can shift deal terms if new key risks or findings emerge, potentially leading to more detailed agreements or, in some cases, causing investors to back out.

Lexi Novitske, a General Partner at Norrsken22, highlighted a growing concern in the African tech ecosystem in the wake of some startup frauds: "I think you’ll see investors conducting much deeper due diligence, including live bank checks, imposing tougher control terms, and displaying overall more risk aversion."

In short, investor due diligence is a deep dive by VCs into your startup's operations, financial statements, and market potential before making an investment decision. You must understand how to prepare for the process to ensure your success.

Preparing for due diligence process in the African tech market 

Preparing for investor due diligence in African tech.

Navigating this phase can be challenging for founders, especially those new to the scene or cautious about divulging sensitive data. However, openness and collaboration are essential to presenting your startup accurately. It's essential to identify and strategise how to address any information gaps that may arise.

Enlisting experts into your team can be a game-changer. Their insights into what investors are looking for and understanding of the local market dynamics are invaluable, particularly in Africa, where local nuances significantly impact business operations.

Recent fraud cases, such as African tech companies overstating their metrics or facing financial difficulties, underscore the importance of due diligence. It safeguards against unforeseen issues, boosting investor confidence in your venture. Proper preparation positions your startup as an appealing investment opportunity and sets the foundation for sustainable growth.

Maya Horgan Famodu, Founding Partner at Ingressive Capital, points out that most of the problems that took place in the African tech ecosystem were caused by founders without solid financial backgrounds. This shows how due diligence investigation is not just a procedural step but an opportunity to strengthen your startup's foundation, making it more resilient and investment-ready.

Timing of investor due diligence

At a notable August 2023 event by A&A Collective and Founders Factory Africa (FFA), experts explained that preparing for investor checks, or due diligence process, can take anywhere from two to five months. While basic financial and impact checks can take two to three months, getting your pitch and financial details ready and talking to advisors can take a bit longer. You need to start getting prepared well in advance. 

What can go wrong: Common due diligence pitfalls to avoid

Due diligence in Africa's tech ecosystem demands transparency and attention to detail. In the case of Dash, a Ghanaian fintech startup, inaccurate reporting and misrepresentation of user numbers led to significant repercussions. Such incidents underscore the need for investors to perform deeper due diligence. This includes live bank checks, tougher control terms, and investment agreements. 

Founders should be prepared for more rigorous scrutiny from investors, particularly international ones, and should have transparent and verifiable business operations records. Local and international VC collaboration is crucial, leveraging local insights for thorough due diligence. Startups, in turn, could raise investor confidence by ensuring data accuracy, maintaining open communication, and developing a culture of integrity.

Eloho Omame, Partner, TLcom Capital and Co-founder of FirstCheck Africa, highlights the venture ecosystem's reliance on mutual trust between founders and investors, emphasising the consequences of its breach. "Founders are generally good-faith actors, and VCs are typically responsible investors. When either of those assertions becomes false, the venture asset class has a severe existential problem."

With a better understanding of how to start preparing for a due diligence process, how timing is crucial, and what could go wrong, let's explore the different types of due diligence you might face.

Types of investor due diligence

Best practices for investor due diligence in African tech.

Types of investor due diligence

For African tech founders entering the investment phase, understanding the types of investor due diligence is crucial for a successful fundraising journey. Here’s a due diligence guide for you to consider:

Financial readiness

Investors will look into your past financial statements, such as cash flow statements, balance sheets, income statements, annual reports, and future projections to understand your business's health. Ensure your financial reports, including revenues, expenses, assets, debts, and cash flow, are detailed, accurate, and transparent. 

Regulatory and legal compliance

Ensuring your startup complies with all relevant laws, licensing agreements, and regulations is non-negotiable. This covers many areas, including company registration, tax compliance, corporate compliance, employment laws, and protecting your intellectual property.

Demonstrating market potential

Investors are looking for startups with a clear understanding of their market size and a solid growth plan. Be prepared to present your market research, competitive analysis, and sales projections. 

Operational efficiency

Efficient operations and strong management are signs of a well-run startup with a promising growth trajectory. Investors will evaluate your management team’s effectiveness, operational workflows, and how your startup scales its processes. 

Risk management

Identifying potential risks and having plans to mitigate them is another critical area. This includes financial risks, market competition, quality risks, legal risks, and operational risks. Being proactive about risk management shows investors you are forward-thinking and prepared for potential challenges. 

Knowing the types of due diligence—from financial scrutiny to operational efficiency and risk management—you're now better prepared to pitch your startup's strengths and potential. Keep these insights in mind as we examine the best practices in due diligence. 

Best practices for African tech startups in due diligence 

Startups with strong early-stage governance processes are more likely to attract investment. Governance refers to the systems and processes that support how your company runs, ensuring they are conducted transparently and in line with established rules and standards.

Founders should prioritise establishing a culture of ethics and transparency to build trust with potential investors. This involves honesty about the startup's capabilities, challenges, and financials. Investors look for strong leaders who can guide the team effectively and make informed decisions while inspiring trust and confidence in stakeholders.

Building sustainable businesses that are not just focused on growth at all costs but also on near-term profitability is becoming more important. Founders should aim to develop long-term relationships with investors by demonstrating financial sustainability resilience and a clear path to profitability.

Your step-by-step guide for investor due diligence

Learn investor due diligence method step-by-step.

Be prepared for investor scrutiny. This includes being ready to provide detailed financial records, user engagement data, and clear evidence of market traction.

Organise documents

Start by creating physical or digital binders containing all relevant documents, such as financial records, legal paperwork, business plans, and market analysis.

Assign responsibility

Designate a team member to manage these binders, ensuring they are kept up-to-date and organised for easy access during due diligence. 

There's been a shift in the African tech scenario towards ensuring startups have a financial operator or an outsourced CFO from the onset. Founders should consider having a core team member responsible for financial operations or engage with third-party professionals to establish sound financial management practices early.

Evaluate investors

Take the due diligence opportunity to assess potential investors and determine if they are suitable long-term partners aligned with your vision and goals. 

Learn from feedback

Apply insights gained from one investor interaction to improve presentations or pitches to other potential investors.

Address concerns

Proactively address common concerns raised during due diligence in future discussions to build investor confidence.

Establish and foster relationships

Use the due diligence process to build trust and mutual understanding with investors, laying the groundwork for a lasting business partnership.

Prepare for the next steps

Anticipate that a successful due diligence process typically leads to the issuance of a term sheet, signalling the beginning of negotiations and further progress in securing investment. Armed with careful planning and an understanding of what to expect, we hope you’re ready to face the due diligence process head-on. 

The road ahead for success in investor due diligence

Investor due diligence is your stepping stone for tech founders aiming to succeed.  Be meticulous, transparent, and ready to show how your startup stands out. 

Now that you know the kind of due diligence you might face, how to prepare for it, the best practices for African tech founders, and how to steer away from the due diligence challenges, we hope you'll put your best foot forward and get your dream investors onboard. 

Your approach to due diligence could be the defining factor in turning your innovative ideas into reality. Seize this opportunity and let Founders Factory Africa help elevate your venture to the next level.