Many SaaS companies go through due diligence in a less-than-ideal state. That’s a lot less stressful when you know what that means.

A while back I wrote about what to expect in SaaS due diligence and provided an interactive institutional readiness report card to help you prepare, but today I want to address the consequences of being unprepared for SaaS due diligence. Founders find themselves in diligence situations feeling unprepared all the time. Could be with a bank for a line of credit. Might be for venture debt. Could be for investment. Perhaps for an exit or partial liquidity event. Or could just be for an annual audit. Diligence is pretty common and universally painful. How painful? That depends on preparedness. Today, I want to look at what it means to you and your process if you go into diligence unprepared. Punchline: It’s not the end of the world. But it’s going to cost you time, resources, and money.

What is SaaS diligence?

It’s strangers going through your closets and hampers looking at your underwear. In SaaS, due diligence processes look at many things at a high level and certain things at a deep and specific level. For more on this look back at my articles on what to expect and how to prepare to be acquired. From a pragmatic perspective, SaaS due diligence is similar to an audit where they take samples of everything and drill into those things where the samples don’t true up. So let’s take the position that some important samples like churn, revenue or COGS don’t true up. That’s what we mean by being unprepared for SaaS due diligence. But what does that mean to the deal?

What is being unprepared for SaaS diligence?

Let’s start with the less painful stuff.

There are many ways you can be unprepared for SaaS due diligence. Contracts could be undocumented. There could be unknown liability or legal exposure. Employee records or policies could be incomplete. And so on. Many things like that do have consequences, but they’re contractual reps and warranties more than they are valuation killers. So in a way, they’re less painful. (Still stressful.)

Reps and warranties are essentially risk mitigators that get written into your contract with the buyer or investor. Anything they’re uncomfortable with, or unsure of, will likely end up in reps and warranties for you to sign off on as your responsibility, not theirs. There are many flavors of reps & warranties — some longer term, some shorter. Some with potentially harsh financial and legal consequences and some not so much.

The more buttoned up you are, the fewer anomalous reps and warranties will be in your contract, and the less stressed you will be to negotiate them out or sign off on them.

The top (or bottom) three ways to be unprepared for SaaS due diligence

There are real, painful consequences that impact the process and financial outcome. These consequences come to be when important SaaS due diligence items are unprepared. My top three ways to get yourself into this super-hot water are revenue, churn, and COGS. There are others, but the consequences are similar, so I’ll just focus on these three.

Consequences of being unprepared in SaaS revenue booking

Revenue a...