Slides from Connect Estonia seminar CONNECT WITH THE SMART MONEY, on August 29, 2006.

1. Due Diligence
Nelson Gray
nelson@nelsongray.com

2. !" # #
$
# $ % # &
# # &
$ '
( # )
* + ,
2

3. Reality
“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”
3

4. 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%
4

5. Perception of the Deal Process
Finding
Deal flow
Initial
Screening
Due
Diligence
Valuation
Negotiation
Legals
Monitoring
Mentoring
Exit
5

6. 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.
6

7. Who does the Due Diligence?
• Lawyers?
• Accountants?
• Consultants?
• The lead Investor?
• Yourself?
7

8. Scope of Diligence
Market Technology IPR Sales & Mkting
•Size •Technical Risks •Patents •Value Proposition
•Trends •Competing •Trademarks •Business Model
•Competition Technologies •Know-How •Sales Forecasts
•Oppts & Threats •Product Mfr •Design Rights •Routes to Market
People Operations Finance Legal
•Mgt Team •Product Delivery •Balance Sheet •Staff
•Key Staff •Customer Support •Cash Flow •Premises
•Roles & •Systems & Controls •P&L •Suppliers
Responsibilities •Health, Safety, •Mgmt Info & •Customers
Environmental Internal Controls
8

9. 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”.
9

10. 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?
10

11. Elements of Due Diligence
• Screening Due Diligence.
• Management Due Diligence.
• Due Diligence on Intangibles.
• Business Opportunity Due Diligence.
• Financial Due Diligence.
• Legal Due Diligence.
11

12. Screening Due Diligence
• Quality of source, the plan, etc
(Use of application forms?)
12

13. Angel Decision Making
• Initial Screening
– Personal Fit & Junk Filter (73%)
• Detailed investigation
– Due Diligence (22%)
• Negotiation and Contracting
– Only 5% get this far!
13

14. Due Diligence on Intangibles
• Not “Intellectual Property” – but -
– Focus, momentum, buzz, your gut feeling.
– Will this be “Fun”?
– Can you add value?
14

15. 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?
15

16. Portfolio Fit?
• What will they be like after the deal?
• How will they behave in the hard times?
16

17. Business Opportunity Due
Diligence
• Customers.
• Business model / scalability / market
channels.
• Can it make required rate of return / IRR?
• Exit.
17

18. 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.
18

19. 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?
19

20. Legal Due Diligence
• History
• Tax
A link between Due
• Structures (EIS)
Diligence and the
• Litigation
Legal process –
• IPR
• Contracts
•Warranties
• Staff
•Indemnities
20

21. At the end of the day
Whatever the Due Diligence Results Suggest:
If it doesn’t feel right, it isn’t right.
21

22. Investor Ready
Reverse Due Diligence
22

23. Gabriel or Lucifer
The 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.
23

24. Due Diligence
Conclusions
• 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.24