Due Diligence: Getting under the skin of your business
Due diligence is essential but founders needn't fear investors looking under the hood, says Praetura's Camilla Greenwood.
The word due diligence makes most people shudder; whether it’s the time commitment of providing “ambiguous” information requests or the fear of uncovering something to price-chip or, worse, kill the deal.
Whilst all these comments are understandable; try and put yourself in the investor’s shoes. Diligence is a chance for us to get under the skin of a business and gain an in-depth understanding to unlock value – it isn’t a test, although it may feel like one.
So, what is due diligence?
All investors have different processes and timeframes, which is why it can be misunderstood. Before any investment completes, investors go through a due diligence process which typically takes three months to complete – not all is visible to the business.
But what does the actual due diligence process look like? Let’s say that we have just invested in a deep tech business. The due diligence phase would provide us with an opportunity to dive deeper into a business’s IP and understand product market fit and the go to market strategy by talking to customers or experts in the space.
Depending on the business, we or another investor may seek to appoint a specialist in IP-related due diligence while we carry out our other checks, including the go to market strategy.
Why we do this
The point of this process, as well as knowing what we’re investing in, is to assess areas such as IP defensibility, the tech roadmap or a solution’s security and data privacy provisions. That’s not to say DD is only carried out on deep tech businesses. DD applies to every business we back.
Don’t fear due diligence
If you’re worried about due diligence, you’re not alone. It’s worth remembering that getting to this stage is a positive. While some do shudder at the thought, the process shouldn’t be feared. Due diligence shouldn’t be seen as a cross examination of you, the founder. Nor is it about calling out faults in a business.
Businesses, particularly those at an early-stage, are very unlikely to pass every marker with flying colours, and that’s fine. The process is designed to help all parties – management, investors and yourself.
Really the due diligence process is about identifying where there could be areas of future risk and where investment and support is required, with the aim of building a more robust business going forward.
Unlocking value through due diligence
It’s true that, at its core, due diligence is a validation and risk mitigation exercise for investors. But, outside of this, there is also a great deal of value and reward for founders. When embraced, it can be just as valuable to founders as investors.
Carrying out robust DD allows investors to understand how they can best support founders. With a deeper understanding of a business’s needs, investors can support with various areas and challenges, such as helping to shorten a lengthy sales cycle or addressing a tech stack that’s not yet easily scalable in its current configuration.
How should I prepare and what is expected of me?
The best approach a founder can take with DD is to be as open, transparent and productive as possible, which is everything the DD process should be as well as collaborative and genuine. To this point, it’s important to note that DD doesn’t just involve one founder or founders.
Investors often want to speak to every member of the management team as well as referencing customers. It’s a collaborative effort. What you can do to help, as the founder, is facilitate access to your tech and product teams, documentation and systems, making the process as smooth as possible.
Having one source of the truth enables alignment across the various stakeholders. With this in mind, it’s also incredibly important that you have a robust data room, which includes management accounts, a forecast model, cap table information, hiring plans, pipeline stats, analysis, market reports, current articles and the shareholder agreement etc. to support claims, such as revenue, customers, market need, size and scalability.
Top Tip
Remember, if you are making any claims in your investment proposition, your investor will want to validate these with clear and concrete evidence, so preparation of this will shorten the time it takes to carry out DD. Some of this information will also be gathered via a management and legal questionnaire, which is standard practice.
