EquityZen's Due Diligence Process for Private Companies: A Comprehensive Guide

Investors Education
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At EquityZen, we believe in the power of investing in the private companies that are shaping the future. While these investments can offer high return potential, how do you sift through the noise and pick the right companies? That is where due diligence comes in to help mitigate risks and unlock the potential for growth. While each investor should do their own research, EquityZen’s research team extensively reviews each of the companies we offer as investment opportunities on our marketplace. Here, we’ll delve into our 5-step approach to due diligence to give you a behind the scenes look of how we evaluate the private company investments we offer to our clients. 

 

EquityZen’s Due Diligence Process

 

1. Sourcing:

EquityZen’s reputation and history in the secondary market has allowed us to build an extensive network to drive differentiated deal flow for our clients. Nearly 100,000 shareholders - from early employees to early institutional investors - have registered on EquityZen’s platform interested in selling their private company shares. As companies stay private longer, some of these early employees may be looking to finance a life event like buying a house or paying off student loans. Meanwhile, early institutional investors may look to sell private company shares to return capital to their limited partners and diversify into new investments. In aggregate, these shareholders registered over $11.58T1 of equity on EquityZen’s marketplace last year alone. This is the top of the funnel that we start with when evaluating which companies we offer to our investors. In fact, less than 1% of shares listed2 on EquityZen’s platform make it to live investment opportunities for our clients.

 

2. Initial Due Diligence

Typically, we look to offer investment opportunities in companies that have the following characteristics: 

  • Stage: post-Series B 
  • Capital Raised: $50M+ from top-tier VCs
  • Valuation: $200M+
  • Exit Timeline: Likely 2-5 years from an exit3 
  • Investor Demand: High (from interest indicated by Accredited Investors on EquityZen’s platform)

If a company meets this criteria we verify the transferability of shares and the ownership status of the shareholder. We only offer investment opportunities in a given company if the shares are legally transferable and if we believe the company is likely to approve the share transfer4. While not eliminating all risk, these steps help ensure the legitimacy and feasibility of the investment opportunity.

 


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3. Capitalization Table Analysis:

Our research team meticulously recreates the capitalization table (aka cap table) for each private company we offer using publicly available information5. This exercise provides insights into shares authorized, shares outstanding, primary issuance prices, conversion prices, share classes, and liquidation preferences, allowing a holistic picture of the equity funding rounds and the relevant preferences and provisions provided to the investors in each round. Altogether, this information helps establish a benchmark  price for the investment opportunities we offer to investors. 

It’s important to understand the price you’ll be paying per share relative to the company’s last round of funding and any liquidity preferences when considering a private market investment. This is why cap table analysis is a crucial part of EquityZen’s due diligence process. You can find out more about the value of understanding the cap table as an investor on our blog.

 

4. Pricing Analysis:

Given that private companies are not required to publicly disclose financial information, we’ve developed a proprietary algorithm that helps estimate how much each share of a private company is worth based on a variety of data inputs. 

This proprietary algorithm considers both quantitative and qualitative factors. Quantitative factors include, but are not limited to, historical and recent transactions, both on and off EquityZen’s platform, Order Book Data (bids/asks), the last funding round price and public market comparables. Qualitative factors include, but are not limited to, business developments, regulatory landscape changes, and other relevant news.

Our research team leverages the deep well of data we have from over a decade of transactions in the private markets. This data includes over 450 privately traded companies and across 40,000 secondary transactions that have taken place on our platform and is a unique differentiator in our pricing analysis. 

Our proprietary algorithm analyzes this data holistically to help establish a pricing range for every private company investment we offer. The research team reviews these prices for accuracy and ensures we only offer Standard Deals that we believe are fairly priced, balancing various market considerations. For a deeper understanding of how we price transactions, check out this blog post

 

5. Preparation of Fund Offering Document:

Once pricing is finalized, our research team compiles details about the investment opportunity, an overview of the company, its customers, business model, management team, funding history, risk factors, and our proprietary analysis of the company's capitalization table into a comprehensive Fund Offering Document for our investors. 

You can think of the Offering Document as a one-stop shop to find a wealth of information about a particular investment offering. It also includes when EquityZen last completed a transaction in that given company, where applicable. 

 

Ultimately, investors decide

At EquityZen, we’re committed to delivering value and mitigating risks for our investors in a market that can be opaque, especially for first-time investors. Our approach aims to ensure that every investment opportunity undergoes thorough review, from sourcing to pricing and beyond. By leveraging both quantitative analysis and qualitative insights, we strive to unlock promising investment opportunities that can drive wealth creation while safeguarding our investors' interests. 

Ultimately, EquityZen was built to democratize access to the private markets and give individual investors the tools to make smart investment decisions. Therefore it is up to each individual investor to decide if a particular investment opportunity is right for them. We encourage our investors to do their own due diligence and provide a few guides to help new investors get started

Interested in making your first investment? You can begin by learning more about our Standard Investment Process

 


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Disclaimers & Footnotes

1. EquityZen data, as of April 16, 2024.

2. EquityZen data for 2023.

3. EquityZen estimate. Not all pre-IPO companies will go public or be acquired, and not all IPOs or acquisitions are or will become successful investments.

4. Although shares may be legally transferable, companies may still block a transaction or exercise their right of first refusal to purchase the shares. 

5. A lack of publicly available and verifiable information can materially impact the accuracy of information provided, including without limitation, estimates relating to the valuation and capitalization of companies subject to investment.

 

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