Forums: Discussions for entrepreneurs and small business.

      I have recently been contacted by a potential investor for a start-up. They are requesting $2500.00 "due diligence fee", is this common practice for this sort of process? Also, is it common practice to not disclose referrals as an investor, or is this considered confidential information?

There really isn’t any gold standard, although most investors who investor for their own account won’t charge any due diligence fees prior to investing.

This may be different if the investor invests on behalf of a fund, or third party accounts. Some investment banks also charge due diligence fees prior to accepting brokerage assignments. In general those investors try to justify this practice by claiming that without doing time -, labor- & cost intensive due diligence, they may be unable to invest due to the inherent risk of facing liabilities brought by their shareholders.

This is certainly up for debate.

In general, I would recommend that you do your own due diligence on people and companies who want to do due diligence on you, especially when they approach out of the blue. Most reputable professionals won’t have a problem disclosing who referred them to you or how they got to your company.

As a matter of fact, if you’re in the market of procuring venture capital investments you will hardly stand a chance without that referral.

So, with other words, if this “investor” doesn’t have a solid and independently verifiable track record and won’t disclose his source or other portfolio companies, just tell them to take a hike.

There’s a lot of fraud going on in this field and it’s common practice among some of these surface skimmers to approach development stage companies, charge them a due diligence fee and walk away from a deal by making a shady excuse as to why they can’t invest. It goes without saying that they will also keep your money and there isn’t much you can do about it unless you can prove they didn’t have the money to invest in the first place. Then, their practice constitutes a criminal offense.

I hope this helps.


Mark



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@doubleday

 

The due diligence process is a necessary and wise business practice.  RobertJ stated that generally professional lenders do not ask for a fee at the beginning.  With this I agree, however most all professional investors will require a due diligence fee PRIOR to funding the venture.  "Upfront fees" are generally used to refer to a fee rendered before any service is given.  There are firms that will charge you an "upfront fee" that is paid to them, whether or not you are approved for a loan.  This is an unscrupulous practice. 

Most professional firms will submit your application, review it, and if there is interest, the lender will contact you for an interview.  It is then that should receive a Letter of Interest (LOI).  You should also request a POF (proof of funds) prior to paying the due diligence fee.  After both parties have agreed to move forward, the borrower will be responsible for due diligence fees.  This ensures that the lender is not wasting money on projects that have been misrepresented by borrowers.  

Contact us for more information on commercial funding programs. 

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My experience was that due diligence fees were always charged, but with a debt investor, the client paid pre-funding. With a private equity investor, the fees were added to the funds requested and paid after funding. In both cases, the due diligence fee budget was presented to the client in advance of a term sheet.

 

Is this a standard practice or are there many variations for payment of these fees?

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Sounds suspicious, tell them to take the 'fee' out of the money they invest before they deposit it into your bank :P

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I agree with Menappi. No kidding, up front fee before they give you money. SCAM!

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