Series A Due Diligence: The Financial Health Audit Investors Actually Run

# Series A Due Diligence: The Financial Health Audit Investors Actually Run

When a Series A investor tells you they're running "due diligence," most founders think it's a formality. They imagine the investor will glance at your unit economics, nod at your growth chart, and wire the check.

That's not what actually happens.

Due diligence is a forensic financial audit. Investors hire external accountants, dig into your transaction logs, trace revenue recognition, validate your accounting practices, and stress-test your financial projections. They're not trying to validate your narrative—they're trying to disqualify you.

In our work with Series A startups at Inflection CFO, we've watched founders get blindsided by issues they didn't know existed: unrecorded liabilities, inconsistent revenue recognition, cost allocations that don't withstand scrutiny, and forecasts disconnected from actual financial performance.

This guide walks you through the specific financial audit areas investors scrutinize during Series A due diligence—and how to prepare so your numbers survive the pressure.

## What Investors Actually Investigate During Series A Due Diligence

Series A due diligence is fundamentally different from seed-stage conversations. At seed, investors accepted narrative and founder capability as substitutes for financial rigor. By Series A, they expect auditable financial statements and internally consistent accounting.

Here's what actually gets examined:

### Revenue Recognition Practices

This is the first place investors dig. They want to understand:

- **How revenue is booked**: When do you recognize revenue? At contract signing, at delivery, at customer payment, or something else? Is it consistent across all customer types?
- **Deferred revenue reconciliation**: If you're SaaS, do your deferred revenue numbers align with your customer count and contract values? Investors will validate this directly.
- **Revenue by customer segment**: Does revenue attribution match your customer data? We've seen founders misallocate revenue across segments, which distorts CAC and LTV calculations.
- **One-time vs. recurring revenue**: Are you blending one-time implementation fees with recurring subscription revenue? Investors separate these because they have completely different unit economics.
- **Customer concentration**: What percentage of revenue comes from your top 10 customers? If it's above 30%, that's a material risk that affects valuation.

Investors will request your revenue detail schedule and trace selected transactions back to original contracts. They're looking for:
- Side agreements that modify contract terms
- Verbal commitments that contradict written contracts
- Unusual timing of large deals ("did you pull in Q4 revenue?")
- Revenue reversals or adjustments that signal quality issues

### Cost Structure and Allocation

This is where founders often stumble. Your cost structure should tell a logical story:

- **COGS allocation**: What costs are truly variable with revenue? If you're allocating fixed overhead to COGS, investors will reframe it. We had a client allocating customer success salaries to COGS because they supported customers—investors reclassified this as operating expense, which cut their gross margin from 75% to 62%.
- **Sales and marketing efficiency**: Your S&M spend should correlate with customer acquisition. If your S&M spend grew 50% but customer acquisition only grew 20%, there's a story to tell.
- **R&D capitalization**: If you're capitalizing software development costs (treating them as assets rather than expenses), are you doing this consistently? Are you deprecating them over the right period? We've seen founders capitalize development costs inconsistently, inflating profitability.
- **Allocation between operating expenses**: How much of your overhead (finance, HR, legal) is allocated to different functions? Investors want to see the true cost of each business function.

### Cash Flow Reality Check

Your P&L might show profitability, but your cash position tells the real story. Investors specifically examine:

- **Days Sales Outstanding (DSO)**: How long does it take to collect payment after invoicing? If your DSO is 60+ days but your narrative says you're SaaS with automatic billing, that's a red flag for hidden payment issues.
- **Days Payable Outstanding (DPO)**: Are you extending payables strategically (delaying payments to vendors)? If your DPO jumped from 30 to 60 days, investors wonder if you're managing cash or in distress.
- **Inventory or work-in-progress**: Do you have materials or projects that aren't converting to revenue? This capital is trapped.
- **Receivables aging**: How much of your receivables is over 90 days old? Investors will suggest a bad debt reserve for anything over 120 days.

We often see founders misunderstand the difference between cash and accrual profitability. [The Cash Flow Timing Mismatch: Why Your Accrual Accounting Masks Real Liquidity](/blog/the-cash-flow-timing-mismatch-why-your-accrual-accounting-masks-real-liquidity/) explains how accrual accounting can mask real liquidity problems. By Series A, investors want to see both metrics and understand the reconciliation.

### Balance Sheet Integrity

Investors verify your balance sheet with unusual scrutiny:

- **Fixed asset schedule**: What physical assets do you own or lease? Are they depreciated correctly? Have you written off obsolete equipment?
- **Intangible assets**: Do you have goodwill, customer lists, or capitalized software? How is this valued? What's your amortization schedule?
- **Debt and obligations**: What loans do you have? What are the terms, covenants, and repayment schedules? [Venture Debt Covenants: The Financial Restrictions Killing Your Flexibility](/blog/venture-debt-covenants-the-financial-restrictions-killing-your-flexibility/) details how many founders miss the real cost of debt covenants.
- **Related party transactions**: Did you borrow from founders? Investors want to know the terms and when this gets repaid or forgiven.
- **Liability reserves**: Have you reserved for legal, tax, or other contingent liabilities? We've had clients with pending patent litigation or employment disputes that weren't reserved.

### Accounting Foundation and Controls

This often surprises founders. Investors don't just audit your numbers—they audit your accounting process:

- **Chart of accounts consistency**: Do your expense categories match month-to-month? We've seen founders reclassify "professional services" between contractors and consulting, making trend analysis impossible.
- **Reconciliations**: Can you produce bank reconciliations, balance sheet account reconciliations, and revenue reconciliations? If your team is doing a manual reconciliation in Excel every month and can't explain a variance, that's a control issue.
- **Supporting documentation**: Do you have contracts, invoices, and receipts to support major transactions? If your largest customer or largest expense can't be documented, that's a problem.
- **Tax compliance**: Are payroll taxes, sales taxes, and income taxes filed and current? Are there any open tax audits or disputes?

## The Series A Financial Audit Timeline: When to Start Preparing

Most founders wait until Series A fundraising is imminent to think about financial audit preparation. This is backwards.

**Start 6-9 months before you plan to raise Series A.** Here's why:

- **Months 1-3**: Audit your revenue recognition. Reconcile your revenue data with your customer and contract data. Fix any inconsistencies.
- **Months 2-4**: Restate your P&L with correct cost allocations. Get comfortable explaining why costs are allocated the way they are.
- **Months 3-5**: Prepare your financial audit trail. Create schedules that support every significant balance sheet account and every material revenue stream.
- **Months 4-6**: Run a dry run audit. Ask your accountant to stress-test your numbers. What questions would an external auditor ask?
- **Months 5-7**: Resolve any compliance issues. File late tax returns, resolve payroll tax disputes, address any outstanding audit adjustments.
- **Months 6-9**: Prepare your financial audit narrative. Document *why* your accounting works the way it does.

If you're 3-6 months from raising, you're already cutting it close. If you're closer, you need a fractional CFO or external accountant to move quickly.

## Red Flags That Trigger Deeper Investor Scrutiny

Certain patterns make investors require a more forensic audit:

**Inconsistent growth patterns**: If your revenue grew 10% month-over-month for six months, then spiked 80% in month seven, investors will dig into that month. What changed? Did a new customer close? Was there a pricing change? A bundle deal? If you can't explain the spike with specificity, they assume the number is soft.

**High gross margins with low dollar-value contracts**: If your gross margin is 85% but your average contract value is $2,000, the math doesn't work. Either your pricing is leaving money on the table, or your cost structure is wrong. We had a SaaS client with 70% gross margin at $1,500 ACV—investors discovered they weren't accounting for hosting costs and customer success labor, which brought true gross margin to 42%.

**Sudden changes in unit economics**: [SaaS Unit Economics: When Your Metrics Lie to You](/blog/saas-unit-economics-when-your-metrics-lie-to-you/) addresses the common mistakes, but if your CAC or LTV suddenly shifts, investors want to understand why. Did you change your pricing? Your target customer? Your sales process? A consistent narrative is more credible than volatile metrics.

**Forecasts that don't reconcile to actual performance**: This is critical. [The Series A Finance Ops Forecasting Trap: Building Models That Survive Reality](/blog/the-series-a-finance-ops-forecasting-trap-building-models-that-survive-reality/) details the common forecasting mistakes. If your forecast from six months ago bears no resemblance to actual results, investors lose confidence in any future projection.

## How to Prepare Your Financial Data Room for Investor Due Diligence

Investors will request an organized data room (usually via Datasite or similar secure portal). Here's what to organize before they ask:

### Core Financial Documents
- Last 24 months of actual P&L statements (monthly)
- Balance sheet at the last close date
- Cash flow statement (actual, last 12 months)
- Board financial statements and board meeting minutes

### Supporting Schedules
- Revenue detail by customer and by contract (last 24 months)
- Customer list with contract dates, ARR, and cohort information
- Deferred revenue reconciliation
- Fixed asset schedule with depreciation
- Debt and loan agreements
- Tax returns (last 2-3 years)

### Forecasts and Models
- Current financial forecast (24 months forward)
- Historical forecast vs. actual analysis
- Unit economics model (CAC, LTV, payback period, gross margin)
- Headcount plan and fully-loaded cost per employee

### Accounting and Controls
- Bank reconciliations (last three months)
- General ledger for last 12 months
- Chart of accounts description
- Accounting policy document (when/how you recognize revenue, depreciation, etc.)
- HR records showing headcount and salary by role

### Legal and Compliance
- Articles of incorporation and bylaws
- Cap table and all equity documents
- Material customer contracts (NDA-redacted if needed)
- Lease agreements and property records
- Tax compliance letters

The key is organization and completeness. Investors assume that missing documents hide problems.

## Common Financial Audit Red Flags That Kill Deals

In our experience, certain issues are dealbreakers:

**Unrecorded liabilities**: We had a client who had agreed to a severance for a departing executive but hadn't recorded it. The investor's audit discovered this via email discovery. It reduced the equity value by 15%.

**Revenue from related parties**: Revenue from other companies you own, or from investors, gets heavily scrutinized. Investors want to ensure revenue is from genuine customers with arms-length pricing.

**Inconsistent tax filings**: If your financial statements show 20% growth but your tax return shows 3%, there's a reconciliation issue. Investors assume tax returns are more honest (less incentive to lie to the IRS than to investors).

**Hidden equity**: If you've granted options or equity that isn't fully disclosed on the cap table, that's serious. [Series A Preparation: The Cap Table & Equity Structure Crisis](/blog/series-a-preparation-the-cap-table-equity-structure-crisis/) addresses this in detail.

**Liens or UCC filings against assets**: If you have venture debt or asset-backed loans, investors want to know what assets are pledged and what claim the lender has. This affects the equity they're buying.

## Getting Audit-Ready: A Checklist

Before you enter Series A due diligence, work through this checklist:

- [ ] Revenue recognition policy is documented and applied consistently
- [ ] All material revenue is reconciled to customer contracts and customer data
- [ ] Cost allocation methodology is documented and defensible
- [ ] Monthly reconciliation of major balance sheet accounts exists
- [ ] Bank and credit card reconciliations are current and reviewed
- [ ] Payroll taxes, sales taxes, and income taxes are current
- [ ] Any contingent liabilities (legal disputes, patent claims, customer disputes) are identified and reserved
- [ ] Debt agreements and covenants are reviewed; you're in compliance
- [ ] Cap table is complete, up-to-date, and reconciles to the balance sheet
- [ ] Financial forecast for next 24 months is prepared and reconciles to your business plan
- [ ] Last forecast vs. actual analysis shows your forecasting accuracy
- [ ] Unit economics (CAC, LTV, payback period, gross margin) are calculated consistently
- [ ] Headcount plan and salary structure by role is documented
- [ ] Data room folder structure is organized per investor request format
- [ ] Key financial person (finance lead, controller, accountant) can explain every significant number

## The Investor Perspective: Why This Matters

Investors conduct financial audits because they've been burned before. They've found:
- Revenue that wasn't real (side agreements, customer disputes, channel stuffing)
- Costs that were hidden or misallocated
- Liabilities that weren't reserved
- Equity that was improperly granted
- Forecasts that were fantasy

Their job is to catch these issues before they wire the check. Your job is to make their job easy—and to ensure there's nothing to catch.

When your financial audit is clean, due diligence moves fast. When there are issues, due diligence gets painful. Every question becomes adversarial. Valuation adjustments and earn-out provisions multiply. Timeline slips.

Get audit-ready now, and you'll raise faster and at better terms.

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## Ready to Audit Your Financial House?

Series A due diligence reveals every financial gap. If you're 6-12 months from fundraising and want to know what investors will actually find, we can help.

**Inflection CFO offers a financial audit readiness assessment** specifically designed for Series A startups. We'll trace your revenue, validate your cost structure, identify hidden liabilities, and prepare your team for investor scrutiny—before they ask.

[**Schedule a free 30-minute financial audit consultation**](#contact) and discover what your numbers will reveal to investors.