Due diligence is the structured work of checking a company's claims and sizing its risks before an investment, acquisition, or senior hire, so the decision rests on verified evidence rather than the pitch. It typically covers the team, market, customers, financials, technology, and legal position.
What due diligence covers
A founder says revenue grew 3x last year, the top customer is renewing, and the CTO built the same system at a larger company. Due diligence is the work of finding out whether each of those statements is true and what happens to the deal if one is not.
The term comes from law and securities practice. Section 11 of the US Securities Act of 1933 gives directors, underwriters and others a defense if they made a "reasonable investigation" before an offering. Its general use now covers any structured investigation before a commitment, including checks on a supplier before a contract, which vendor scoring formalizes. In investing it splits into workstreams:
- Commercial: market size, competition, customer interviews, retention, pricing power.
- Financial: quality of earnings, revenue recognition, cash burn, working capital.
- Legal: corporate structure, cap table, contracts, intellectual property, litigation.
- Technical: architecture, security, technical debt, who actually wrote the code.
- Team: references, track record checks, and how the founders work together. For senior hires the same discipline is called underwriting talent.
Due diligence in venture capital and private equity
Diligence sits in the middle of the deal funnel, after deal screening and before the vote. Survey data shows how selective that point is.
In venture, the survey of 885 VCs by Gompers, Gornall, Kaplan and Strebulaev found that about half the deals reviewed at a partners meeting moved on to due diligence, and about a third of those received a term sheet. The average deal took 83 days to close. The average firm spent 118 hours on due diligence over that period and called 10 references. Late-stage firms called 13 references on average and early-stage firms 8.
In private equity, a 2020 survey of more than 200 PE managers by Gompers, Kaplan and Mukharlyamov found business model and management team were the criteria they weighed most in a new investment. Diligence can also undo a deal late: 14.6 percent of the managers expected to walk away from deals they had already signed, because terms agreed before the pandemic no longer looked attractive. PE diligence is heavier on financials and operations, because the firm usually takes control and uses debt.
Worked example: checking a Series A claim by claim
Northwind Ventures, a fictional fund, is leading the Series A of Quarry Health, a fictional clinic scheduling startup. The associate lists every claim in the deck and assigns a check to each.
- Claim: 140% net revenue retention. Check: monthly revenue by customer cohort. Finding: 140% holds, but one customer accounts for most of the expansion. Without it, retention is 118%.
- Claim: three paid pilots converting to annual contracts. Check: calls with all three customers. Finding: two have signed. One is on hold pending a budget review.
- Claim: the CTO built the payments system at a large software company. Check: two references. Finding: confirmed. She led a team of four on it.
None of the findings kills the deal. They change what the investment memo says: retention is stated as 118% excluding the largest account, and customer concentration moves to the top of the risks section. The investment committee votes on the checked version, not the pitch version.
Commercial vs financial vs legal due diligence
| Commercial | Financial | Legal | |
|---|---|---|---|
| Main question | Will customers keep buying, and will the market grow? | Are the numbers real and repeatable? | Does the company own what it says, free of hidden obligations? |
| Typical evidence | Customer calls, cohort data, market sizing, win and loss records | Ledgers, bank statements, quality of earnings report | Charter documents, cap table, contracts, IP assignments |
| Who does it | Deal team, sometimes a strategy consultant | Deal team plus accountants | Outside counsel |
| Weight in early VC | High | Low, little history to check | Medium, mostly cap table and IP |
| Weight in PE buyouts | High | Very high | High |
Common due diligence mistakes
- Confirming instead of testing. Diligence that only looks for support for the thesis finds it. Write down what would change your mind before you start.
- References the founder chose. Add back-channel references the founder did not suggest.
- Findings that never reach the memo. A risk found in week three and left out of the write-up was not diligenced, just noticed.
- Checking the business and skipping the people. VCs in the Gompers survey ranked the team as the top factor in both selection and outcomes. Score the team with the same rigor as the numbers, as in founder scoring.
- No source on each finding. Every conclusion should point to the document, call, or dataset it came from. That is the core of evidence-based scoring.
How ScoringFactory approaches due diligence
ScoringFactory scores founders, companies, and candidates against a team's own bar and ties each score to the record behind it, cited to the line. In diligence, that gives the deal team a starting view of what is supported and what still needs checking, and a record of how the view changed. The team does the diligence and makes the decision. See the use cases.
Frequently asked questions
What does due diligence include in venture capital?
At early stage it is mostly about the team, the market, and the first customers: reference calls, customer calls, a product review, and a cap table check. Later rounds add cohort analysis, financial review, and technical review. In one survey of VCs, the average firm spent 118 hours on diligence per deal and called 10 references.
How long does private equity due diligence take?
It depends on deal size, complexity, and whether a banker is running the process. In an auction, the seller's timetable sets the pace and diligence is compressed into fixed rounds. In a proprietary deal, the firm can take longer. Large buyouts involve accountants, lawyers, and consultants working in parallel, so the elapsed time and the effort are both much higher than in venture.
What is the difference between commercial and financial due diligence?
Commercial diligence asks whether the business will keep winning customers: market, competition, retention, pricing. Financial diligence asks whether the reported numbers are accurate and repeatable: revenue quality, margins, cash flow, and working capital. A company can pass one and fail the other, for example clean books in a shrinking market.
Who does due diligence at a fund?
The deal team leads it, usually a partner with one or two associates or principals. They bring in lawyers for legal review, accountants for financial review, and sometimes consultants or industry experts. Findings go into the investment memo, which the partner presents to the investment committee.
Sources
- Securities Act of 1933, as amended (Section 11), US Government Publishing Office, current text
- Gompers, Gornall, Kaplan and Strebulaev, How do venture capitalists make decisions?, Journal of Financial Economics, 2020
- Gompers, Kaplan and Mukharlyamov, Private Equity and COVID-19, National Bureau of Economic Research, 2020