taming the dragon- secrets of due diligence (nelson gray)

Due Diligence

Nelson Graynelson@nelsongray.com

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“I should have done a lot more due diligence because a lot came out of the woodwork in the balance sheet in a very different light and I would never have invested. If I had to do it again, I would have dug deeper and not been in such a rush to put the money in”

Reality

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Post Investment Depression

• Wish I had:– Done more due diligence – 36%– Had more contractual control – 13%– Invested more – 8%– Not invested – 8%– Recruited more people – 6%– Monitored more – 3%

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Perception of the Deal Process

FindingDeal flow

InitialScreening

DueDiligence

ValuationNegotiation

Legals

MonitoringMentoring

Exit

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Due Diligence

Why do it ? The Investor -• To get to know the management.• Evaluate the opportunity against your

investment criteria / strategy.• To reduce your risk – find the “lies”.• Identify areas for focus – danger areas.• To make go/no-go decisions.

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Who does the Due Diligence?

• Lawyers?• Accountants?• Consultants?• The lead Investor?• Yourself?

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Scope of DiligenceMarket

•Size•Trends•Competition•Oppts & Threats

Technology

•Technical Risks•CompetingTechnologies•Product Mfr

IPR

•Patents•Trademarks•Know-How•Design Rights

Sales & Mkting

•Value Proposition•Business Model•Sales Forecasts•Routes to Market

People

•Mgt Team•Key Staff•Roles &Responsibilities

Operations

•Product Delivery•Customer Support•Systems & Controls•Health, Safety,Environmental

Finance

•Balance Sheet•Cash Flow•P&L •Mgmt Info & Internal Controls

Legal

•Staff•Premises•Suppliers•Customers

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Due Diligence – When?

• Before you get the Plan.– General Market Knowledge.– The Source of the Deal.

• When you read the plan.– Personal Fit.– Common Sense.

• When you meet the Management– Do they have “it”.

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Due Diligence – When?

• During Negotiations– What are Management like under stress?– Still a consistent story?– Are they listening?

• Before you Sign the Paper– Have a reality check

• Business Still on Track?• Deal still Sensible?

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Elements of Due Diligence

• Screening Due Diligence.

• Management Due Diligence.

• Due Diligence on Intangibles.

• Business Opportunity Due Diligence.

• Financial Due Diligence.

• Legal Due Diligence.

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Screening Due Diligence

• Quality of source, the plan, etc(Use of application forms?)

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Angel Decision Making

• Initial Screening– Personal Fit & Junk Filter (73%)

• Detailed investigation– Due Diligence (22%)

• Negotiation and Contracting– Only 5% get this far!

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Due Diligence on Intangibles• Not “Intellectual Property” – but -

– Focus, momentum, buzz, your gut feeling.– Will this be “Fun”?– Can you add value?

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Management Due Diligence

• Managements view of investors.• Their motivation.• Are they really Entrepreneurs?• Do they have a CEO?• Why will they be a successful team?• Can you add anything?

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Portfolio Fit?

• What will they be like after the deal?• How will they behave in the hard times?

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Business Opportunity Due Diligence

• Customers.• Business model / scalability / market

channels.• Can it make required rate of return / IRR?• Exit.

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Remember the Basics

• Technology is rarely the reason for failure.

• Sales and marketing areas of weakness– Many companies lack “polish”.

• The USA seen as a key market– but most Non US companies struggle with this.

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Financial Due Diligence

• Historical, Forecast & Present.

• Burn rate.

• How cash to be used – development or past failings?

• What did the last business plan promise?

• Is the next funding addressed in the plan?

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Legal Due Diligence

• History• Tax• Structures (EIS)• Litigation• IPR• Contracts• Staff

A link between Due Diligence and the Legal process –

•Warranties •Indemnities

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If it doesn’t feel right, it isn’t right.

At the end of the day

Whatever the Due Diligence Results Suggest:

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Investor ReadyReverse Due Diligence

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Gabriel or LuciferThe Companies Due Diligence.

• Basic Chemistry» Do you like them?» A balanced Board - match long term

needs of Co» Control demands reasonable» Distribution requirements reasonable

• Get References• Watch out for tyre kickers• Do they have the cash? – Follow on• Work with them before committing.

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Due DiligenceConclusions

• It’s an ongoing and continuous process.• It’s an evaluation against personal criteria.• Results will be evaluated in a personal

manner.• It should take a reasonable amount of

time.• Have a reality check before moving on.• It should be a two way process.• It provides opportunities for entrepreneurs.