Due Dilligence for the Detail Challenged Business
By Alan W. Urech
During the past few years, entrepreneurs have continually asked me the question, “What due diligence is now required by angels and investment capitalists?” They want to supply the information and knowledge, but question what that consists of. Entrepreneurs are now more than ever cognizant of the need for advice and consultative support to find the right mix of diligence that is needed to position their company in the best but most honest spotlight of where it is at the current time.
In the 1990s, company due diligence was not as much of a challenge because the passion of the leadership team, the market opportunity and the idea sometimes overcame the actual comprehensive business checks that are now being completed by our sophisticated angel and venture capital communities. The 1990s were exhilarating times where the anticipation of huge profits on innovative ideas overwhelmed the actual doing diligence on whether the management, business strategy or market opportunity was actually there to make money.
Well, because of lessons learned, comprehensive company due diligence is back in fashion today and getting strong support by the venture community. Why? Investors are still smarting over large capital losses from not completing comprehensive due diligence during the 1990s. We learn from our experience and knowledge, but sometimes a bucket of cold water helps.
Let’s get into the “Grit” of what is needed by today’s sophisticated investor and let’s do it by the numbers. Here are a few rules and suggestions to follow.
First and foremost, with all your company due diligence, be honest. Show where the company is at the time of investment to the best of your knowledge. Please do not over amplify, do not hide or keep anything under the covers. Full disclosure is best and being honest about where you are at this point of time is crucial. Let the Investor determine where the chips may fall. Just provide all the information. I remember one client of mine that exaggerated their market opportunity significantly and their ability to capture most of it. The angel investor just did some simple Internet searches and found out some significant competitors that were well capitalized and probably would not let their market share erode without guerrilla warfare. The angel did not trust the company management after this was determined and just quietly moved on to the next opportunity. There is no second chance to gain trust and a strong partner.
Second, understand that company due diligence is not an easy process. It is painstakingly detailed, time consuming and challenging. Only the most passionate entrepreneur will complete it and succeed, noting that the end product will strengthen their chances for capital when competing against those who did not give it the same respect. The company will have to slice and dice their information many different ways before the process is completed, knowing that different investors see the opportunity in diverse ways.
It is best to be completely upfront with the investor and provide an easy format for him or her to see the business as they want to review it. Often I see the entrepreneur wants to portray the business as the entrepreneur wants to see it which is different from the investor. Bad idea. The entrepreneur does not hold the “money cards,” the investor does. Once the due diligence process is completed, the investor will want to see a strong, focused company that has all the elements of success written all over it. Remember: The seller wants you to buy the future. The buyer wants you to buy the past.
Third, understand the due diligence components the investors are looking for. They are looking at you to clearly “show them the money.” They don’t have time to dig information out from the mud under a rock. Due diligence consists of detailing everything about the company from the backgrounds of the leadership team through the exit strategy. Normal due diligence consists of clearly detailing information about the management team, business strategies, sales and marketing strategies, market opportunity (and the company’s part of that), how revenue is made, products/services offered, current investors, liens, debt, financials and financial projections (5 year), customers, prospects, strategic alliances, competition, board and advisory board members, employees, intellectual property, challenges faced and the use of the investment funding.
The management team’s background is normally checked out for any criminal convictions or anything in their past that could be detrimental to the investment. What a well-built and well-thought out company wants to do is to supply this information upfront to the investor so that they have it available to make an informed decision. That doesn’t mean that they won’t do their own diligence in addition to the companies, but that information should parallel the company’s own.
Bottom line: Investors want you to weave a compelling story of how the company, with their investment, will be successful and make them lots of money.