The Devil is in the Diligence: Conducting Due Diligence for Tech Start-Ups

For start-ups of any industry or sector, securing funding from an investor is reliant upon your early-stage company’s ability to match against a series of criteria; the extent to which will be determined by the investor conducting due diligence. Defined as a ‘systematic way to analyse and mitigate risk from a business or investment decision’, investors perform due diligence to ensure that their investment capital is well-placed and profitable, and thus it forms a hinge upon which the investment cycle rests.

In a previous article, we discussed the importance of self-due diligence when preparing for a divestiture or acquisition. In this article, we draw upon our investment expertise and experience to apply this process of scrutiny to uncovering any weaknesses before a potential investor identifies them. Here, we examine key factors specific to tech start-ups.

Financial Factors

It's no surprise that financial health is one of the first areas scrutinised by investors, especially regarding profitability and scalability. These are particularly critical for tech start-ups, which often take longer to achieve profitability. Read on for strategies to address these challenges early.

Profitability

Start-ups in the technology and biotechnology sectors are high-growth, often offering complex products that require considerable research and development (R&D). Compounded by crowding in a saturated and competitive market, this delays the time until such organisations can generate enough revenue to be profitable. This demands more upfront investment compared to sectors like retail or services, leading to delayed revenue generation.

Because of this, investors will scrutinise burn rate—the rate at which a start-up spends its capital—and runway—how long the company can sustain operations at the current burn rate without needing additional funding. Anticipating these questions is critical, so ensure you're equipped with accurate financial projections.

Scalability

Although profitability might be delayed, the ability to scale can compensate for this. According to a study by McKinsey & Company, ‘While most companies tend to focus on launching new businesses, the real value comes from being able to scale them up. Based on analysis of US venture-capital (VC) data, two thirds of value is created when a company scales up to penetrate a significant portion of the target market.’

The right technology stack will catalyse this process, making it easier to acquire customers, expand markets, and scale up.

Another strategy to support scalability is the use of Fractional Leadership. With this model, start-ups have access to highly experienced professionals on a part-time or project basis, offering expertise without the full financial commitment of permanent hires. We’ve previously detailed how Fractional Leadership can be a cost-effective solution for growing start-ups in this article.

Security & Compliance

Beyond financial factors, risk management is a growing concern for investors—particularly for tech start-ups handling large amounts of digital data. Cyber security failures can lead to substantial financial losses (the average data breach costs $4.3m) and irreversible reputational damage. Expect a potential investor to scrutinise all aspects of your organisation for chinks in your digital armour.

A strong cyber defence aligned with frameworks like NIS2 (the latest version of the EU’s Network and Information Security Directive) is essential. Not only does compliance with regulations strengthen your cyber defences, but it also ensures that your start-up aligns with international regulations—important for attracting investors with global interests.

Sustainability

Sustainability is no longer a nice-to-have—it’s a must for attracting modern investors. In a ‘Sustainable Signals’ report by the Morgan Stanley Institute for Sustainable Investing, 77% of investors expressed a preference for companies that balance financial performance with social and environmental responsibility.

Nearly 80% of global investors consider a company’s environmental metrics, such as carbon footprint and greenhouse gas reductions, when making investment decisions. To stand out, your start-up should not only measure its environmental impact but also transparently report on how it integrates sustainability into business operations. Greenwashing or vague ESG claims will quickly dissuade investors, so ensure your data is credible and trustworthy.

Conclusion

As highlighted throughout this article, performing thorough internal due diligence is vital for anticipating the scrutiny your start-up will face from potential investors. Getting this right will significantly improve your chances of securing investment and positioning your start-up for future growth, including go-to-market stages.

Approaching this with a comprehensive strategy is essential, and this can be facilitated by partnering with experts who have the necessary insight and experience. 

Cambridge Management Consulting, founded to support the growth of innovative start-ups in Cambridge, offers a range of Technical and Commercial due diligence and legal services globally. Learn more about our Due Diligence offering and expert advice here.