I got a fair number of cost inquiries on my recent post about due diligence for raising venture capital. This post has a few thoughts on what those costs are by deal size.
Keep in mind each deal is different. A seed round may not trigger the depth of due diligence and legal paperwork as a later round. Deal costs as defined below include those activities from reviewing a term sheet to signing a purchase agreement. Click here to see a handy grid of deal activities and actors.
Typical Deal Costs
Series A deal costs include costs for both the investor and portfolio company. If the deal falls through, the portfolio company is on the hook for its fees only.
This starts with the term sheet review and goes all the way through a purchase agreement. The investor’s legal team will likely conduct legal due diligence on the company and advise on any risks they discover. This is a key part of due diligence so it is important that your legal docs be in order.
Typically this is an audit or review of your financials. This should be done prior to due diligence, if possible. Get a review if you can – they are cheaper and have a lower threshold of validation than an audit. They are also faster to complete (time kills deals). Accounting fees may also include due diligence support for the portfolio company, investor, or both.
Investors want external validation of your company so they may pay independent consultants to verify their findings. These costs may include product testing, market research, consumer data, customer contacts and background checks.
Investment banking fees
If you’ve engaged an investment banker to raise capital, their fee will be part of the closing costs. They typically charge a retainer and success fee equal to a % of the total deal value. The retainer is usually folded into the success fee post-close, but if the deal does not close you’ll still owe the retainer.
Deals up to $5 million
For a deal without investment banking fees, budget something like $100,000 for a $1M deal and $300,000 for a $5M deal. If you engage an investment banker, he or she will usually charge a success fee of about 5% for deals this size. Most investment bankers have a minimum deal size of $5M.
Angel deals up to $1M primarily have mostly legal fees as closing costs. These rarely exceed $50,000 or so. Some deals may have accounting costs as well to clean up the books for investor review. This may amount to a few thousand dollars.
Deals over $5 million
Series A deals over $5 million typically have closing costs of about 5% of the deal before the investment banking fee. For larger deals the success fee declines. According to the 2017 M&A Fee Guide put out by Firmex Divestopedia, most success fees were 2-4% for deals between $10M – $20M. So, a $20M raise with investment banker assistance may cost about 8%.
Ask Your Investor
When you are in term sheet negotiations it is entirely appropriate to ask what the investor expects the closing costs to be. After all, they want to minimize closing costs so they can put more of their capital to work in their investments.