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Are Formal Background Checks Necessary in Startup Fundraising?

     

The leaders of fledgling startups that seek capital and perhaps are not familiar with the fundraising process are often taken aback by some of the questions and requests they receive from prospective investors. A prime example of such an unexpected inquiry pertains to investor requests for what is in a sense a type of personal due diligence. Before even getting to the main due diligence investigation in which the company's financial and legal matters are subject to rigorous scrutiny, a lot of investors will want to learn about the founders themselves, and maybe even some of the other company personnel.

 

In most cases, this will entail a formal background check, much like the type a potential employer will conduct, to determine whether a person has a sordid criminal or financial history. But, just because there may be a blemish on someone's record, that does not always mean the deal will immediately die. If and when an individual with a past is asked to submit to this sort of check, it will be wise to be forthcoming rather than try to conceal the truth and hope the check does not reveal it. With the right level of honesty and contrition, this will at least show a person's forthcoming nature and sense of integrity, which may help mitigate the negative reaction to the background check's findings. Here are some of the things the investors will likely want to know about and thus will understandably require a formal background check:

 

Shady Dealings

One of the primary concerns for any investor is whether they are getting a good deal or are perhaps being duped into forking over money. Unfortunately, there are a lot of sketchy people who routinely engage in shady dealings at someone else's expense. Smart investors will mandate a background check that will involve some kind of review of both criminal and civil court records to determine whether those under scrutiny previously engaged in shady dealings. In some situations, this may be difficult to ascertain if the authorities did not catch the person or those affected did not sue for wrongdoing. As a result, investors may even ask to speak to former and current business partners or associates to get a sense of a person's moral character. This may seem intrusive, but it has become a necessity in a world dogged by scandal. And, for people with nothing to worry about, acting miffed at this request may cause others to believe that they are hiding something.

 

Patterns of Default

Shady dealings may be hard to pinpoint, but defaulting on loans or other financing arrangements is usually pretty hard to conceal. A credit report will surely be run, with particular attention paid to a person's or company's financial payments history and the status of existing accounts. Obviously, investors will be less than thrilled about handing over money to those who consistently failed to meet their financial obligations. Granted, there may have been instances in which a person or company had to make a strategic default, but this should be fairly easy to clarify. Of course, none of this will be an issue for companies that simply play by the rules.

 

Minor Infractions

In addition to the business and financial side of someone's past, the background check will likely delve into other criminal matters, mainly because investors will be hoping to avoid any potentially embarrassing associations. More than likely, minor infractions such as underage possession or an excessive number of traffic violations won't be complete deal breakers, although some people may construe certain patterns as indicative of reckless behavior. The background check clearly gives prospective investors the opportunity to better understand the people running the startup they are considering supporting and to whom they may be entrusting vast sums of money. Even though investors likely have different views as to what constitutes a problematic past, actions that occurred a long time ago, had little to no consequence, and/or are not related to business or money probably won't be an issue. Ultimately, investors have the right to know exactly the type of people with whom they are going to be dealing.

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