Investor due diligence
Due diligence is a process that verifies and confirms statements and views about a business and its prospects. Due diligence reduces the risks of an investment.
Every deal has risks attached to it so that you need to understand what risks to accept and which demand more detailed investigation.
Tip: The due diligence process can be shared amongst syndicate members. Members with the most appropriate skills, experience and knowledge can undertake one or more areas of due diligence.
The top three main criteria used by venture capital investors (and therefore broadly applicable for business angel investors) in assessing a potential investment are:
2. exit; and
3. revenue potential.
Therefore, a due diligence programme should focus on addressing these key criteria.
Management due diligence
Management is a key area to undertake due diligence. As an investor, you will be working closely with the management team for up to several years so that it is essential that you are as comfortable as possible with management.
Spending as much time as possible with management will help you form a view about the team and their capability to execute the business plan successfully.
Taking up references from as wide a circle as possible is ideal, e.g. from previous employers, customers (past, present and potential), suppliers, funders and anyone that may have a business relationship with members of the management team.
Exit due diligence
Understanding the potential exit opportunity is the second key area. The most likely exit is a trade sale to another player in the market. This could be a customer, supplier or other partner.
Assessing the likelihood that the potential company could be a target for a takeover can be challenging, particularly with a young start-up company perhaps entering a new and growing market. Nevertheless, it would be worth spending some time considering this issue since an exit route is the key to successful investing.
The assessment may include ‘what does the company need to look like?’ in order to be purchased. This could include required future levels of turnover, employment, technical know-how, intellectual property protection and profitability – some or all of these elements may make a company an attractive takeover target.
An intellectual property based sale can be attractive since significant commercial scale is usually not required.
Due diligence areas
|Commercial and operational
||• Company's strategy for delivering identified revenue enhancement and/or cost savings
• Technical merits of product/service offering
• Strengths of customer and supplier relationships
• Competitive positioning
• Market outlook
• Ability to influence the market
• Possible synergies
||• Assessment of capability – management interviews
• Identification of gaps and future plan
• Take up references from previous employers, customers, suppliers and funders
|Financial including tax and pensions
||• Historic financial performance
• Current financial position
• Financial model and projections
• Tax: all taxes (corporation tax, VAT, employment taxes, rates, stamp duty, import duties, etc.) including deferred tax provided in balance sheet
• Pensions: adequate provision in balance sheet
• IT status and future requirements
||• Environmental risk of a company's site(s)
• Highlight any non-compliance with environmental regulations or company's own policy
• Assessment of any ‘contaminated land’
|Risk management and insurance
||• Assessment of any present, future and past exposures
• Legal compliance with statutory obligations
• Ownership of the company's IP including patents
• Shares properly issued
• Assessment of any shares 'promised' to current or former promoters and/or employees
How much is appropriate?
Not all of this will be applicable to a start-up or young company but they at least should be considered.
A sample commercial and legal due diligence questionnaire is included in Appendix A of our investor Guide - Investing in Private Companies Insights for Business Angel Investors
Entrepreneur due diligence
Entrepreneurs can also undertake due diligence on you, checking your record of support or otherwise, so be prepared for this…
This may be a challenge for entrepreneurs since angel investors do not generally have a website or publicly available information. However, this is a small Island and someone will tell what they know about you…
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