2. What we’re going to talk about ...
What “Due Diligence” is, and why it
matters to you now.
The different kinds of investors, and
what kind of information will each
investor type want to see.
3. What is “Due-Diligence?”
Once you have an investor interested in your company’s potential, you will need to
gather and present a wide range of information for him to analyze before making a
decision.
For the investor to be convinced he’s making a good investment decision, he will be
“diligent” in what information he considers
The result is a report that either recommends an investment or describes why an
investment is not warranted:
• Market Structure, Competition, and Marketing Strategy
• Technology Assessment
• Management Team
• Operating Plan
• Financial Prospects
4. It’s not about risk …
… it’s about uncertainty.
Every investor understands that even well-planned ventures have risks:
•
The technology might not work
•
The management team might make poor decisions
•
The customers might not buy the product
Investors HATE uncertainty – they want to hear you say:
•
“We’ve tested the technology and here are the results!”
•
“We’ve run similar ventures before, and here are our resumes!”
•
“We’ve talked with potential customers, and here’s what they told us!”
5. Certainty increases as the company matures
Venture Performance
Embryonic
Launch the
venture,
establish
competitive
position
Uncertainty
= 100%
Growth
Grow &
improve
competitive
position
Increasing
clarity
Mature
Executing a
known business
model
Sustain
competitive
position
Venture Maturity
Source: Third Generation R&D, Roussel, Saad, & Erickson
Aging
Abandon?
6. Your only focus should be …
Do everything you can to reduce uncertainty!
“Certainty is the mother of quiet and repose, and uncertainty the
cause of variance and contentions” -- Edward Coke
“Fear comes from uncertainty. When we are absolutely certain,
whether of our worth or worthlessness, we are almost impervious
to fear.” -- William Congreve
“Education is going forward from cocksure ignorance to
thoughtful uncertainty” -- Anonymous
7. Revenues
Start-up Venture Financing
Early Stage
(Angels & VCs)
Seed Capital
(Friends/Family
& Angels)
Later Stage
( VCs & Strategic
Partners)
Valley of Death
Time
Growth
Stage
(IPO,
Investment
Banks)
8. Different Information for Different Investors
The type and amount of information you’ll need to gather
and present will depend on how mature your company is and
the type of investor you seek.
You should be open and honest about how you plan to
execute the business.
It is NOT your responsibility to tell the investor what he
should consider or how he should analyze the information!
9. Typical Investment Criteria
Management Team
Proprietary Advantage
Full-Time Commitment
Unique technology with defensible IP
Integrity
Difficult-to-replicate business model
Passion
Scalability
Coach-ability
Markets with big buying power
Creativity
Potential to dominate market
Record of High Achievement
Large-scale production & delivery
economics
10. Investors look for an advantage
1.Real intellectual property
2.A dynamic product line
3.Dramatic cost reductions
4.Proven team
5.Lock on the market or customer base
6.Strong focus and differentiation
11. Investors will want (at least …) 3
things in the deal
1. The liquidation preference
2. The right to participate pro-rata in
future rounds
3. The right to a board seat
13. How important is each focus area?
Focus
Area
Friends &
Family
Angel
Investor
Strategic
Investors
Venture
Capital
Market
Structure
Technology
Assessment
Management
Team
Operating
Plan
Financial
Review
14. Let’s look at the worst case
The following is a “Due-Diligence Checklist” from a
Venture Capital (VC) firm in Washington, DC.
60-70 specific questions
Some questions might take 20-30 hours to answer
completely
(Don’t worry, we won’t go through them all in detail …)
15. Market Structure, Competition, and Marketing Strategy
To what market does this product service belong? What major subgroups of
services/products or customers exist in this market? What is the size and growth rate of
the relevant segment(s)?
Who are the ultimate customers? Why will they (do they) buy the product or service?
Why would they switch from their current solution to the company's product or service?
What would stop them from switching?
How do suppliers reach the customers (advertising, direct sales, etc.)?
Where does the company fit in the chain of production between raw materials and the
ultimate customer? What companies are downstream and would motivate customers to
buy from this company? Will those key downstream companies agree to be attentive
distributors?
Does the company plan to alter the supply chain? What evidence exists that such a
change is possible?
At what stage is this market: (a) Pre-commercial; (b) Emerging; (c) Growth; (d) Maturity
?
What are the barriers to entry/exit of competitors? What prevents new companies from
entering the market? Who are the likely entrants? What delays the exit of unsuccessful
competitors?
16. Market Structure, Competition, and Marketing Strategy
What means of promotion will be used? Will there be cross-promotion
with another product or company?
How is the product sold (independent sales force, in-house sales,
etc.)? What is the length of the sales cycle?
Who makes the purchase decision? Describe the decision process.
How will the company influence the decision?
Is there seasonality in the decision to buy the product or service?
What are the normal terms for payment? What is the provision for
customer service?
What incentives are offered to reseller, distributors, retailers, and the
like?
What distribution channels are available?
How influential are distributors, retailers, system integrators, training
organizations, and the like? How will the company influence them?
17. Market Structure, Competition, and Marketing Strategy
Who are the competitors (current and likely entrants) and
what market share do they currently capture?
What are the strengths and weaknesses of each competitor
vis-à-vis this company?
How aggressively has each competitor responded in the
past to new entrants or competitor moves? What tactics
has it used?
How does each competitor try to maintain or improve its
market share?
18. Technology Assessment
What is the company's technological advantage?
How important are the features offered by the advanced technology to customers?
How easily can competitors copy or circumvent the technological advantage?
What stage of maturity is the technology: (a) Idea Stage; (b) Proof of Concept; (c)
Prototypes Available; (d) Alpha Stage; (e) Beta Stage?
What outside agencies have shown support for the technology (federal government,
state technology supporters, universities, etc.)? Why?
What outside resources can be drawn upon to advance the technology?
Have patents been issued or applied for? What do the patents cover that provide a
sustainable competitive advantage?
Does the company have the means to defend their patents against infringements by
competitors?
Have appropriate licenses been obtained for technology that is integral to the product or
service, but which does not belong to the company? What are the terms (exclusive or
non-exclusive, sunset clause, payment schedule?
19. Management Team
Is there a well-researched and thoughtful Business Plan in place?
Is every key manager and professional experienced enough to execute the Business
Plan?
What deficiencies exist in the management team skills?
How will the company recruit and retain key management talent?
How does the management team compare to that of competitors?
What motivates the management team?
Has management returned wealth to investors previously?
Have all key personnel signed non-compete agreements with the company? Do they
have any commitments with prior employers that limit their ability to perform for the
company?
What does the Board of Directors/Advisors contribute to the company (advice, money,
market contacts, recruiting contacts, etc.)?
How is the Board compensated?
Do current investors present a cohesive and manageable group?
Is there relative unanimity of vision amongst the management team, Board members,
and investors?
20. Operating Plan
How large is the development team? Is the size representative of
industry norms?
What arrangements are needed with suppliers and distributors?
When will they be in-place? Are there multiple suppliers and
distributors?
Does the proposed spending and staffing fit the marketing
strategy?
How will the company recruit and retain key marketing talent?
Do the staffing levels for accounting/finance and Human
Resources fit industry norms given size and maturity of the
company?
What types of information systems does the company have? Do
the quality of the systems, and the size of the staff necessary to
maintain them fit with industry norms?
21. Start-up Milestone Description
Completion of concept
definition and initial product
testing
The company is able to articulate the combination of an identifiable market need and a product or
service that will meet that need that is technically possible and fundable through reasonable means.
Completion of prototype
product
A prototype product can be alpha-level software that establishes functionality on an appropriate
platform, or, in the case of engineered products, a breadboard-level system that shows the capabilities
in representative environment.
First financing
First significant outside funding, (not counting “Friends, Family, and Fools” or small government
sources) from a sophisticated investor (Angel), vendor financing, VC, or other seed-stage source.
Completion of initial
production and operations
testing
Processes in place that indicate the product can be manufactured and delivered, and/or the service can
be delivered on time and with sufficient quality, etc.
Market testing
Initial large-scale marketing of the product or service in advance of full scale production
Production start-up
The point at which the market is sufficiently well understood to begin putting production processes in
place.
"Bellweather" sale
The first time the company identifies a major target sale, mobilizes to address that target’s needs, and
captures the work. In other words, the first time significant revenue is generated through conscious
action and mature processes rather than dumb luck.
First competitive action
The first time a competitor emerges and forces an action on the part of the client to retain a current
customer or compete for a new customer.
First major redesign or redirection
The first time, in response to either of a threat or an opportunity, the client undergoes a significant
redesign of current products and/or services, or develops new products or services that will
significantly enhance the current offerings.
First major price change
The first time the company is forced to alter prices for existing products, and yet maintain quality and
functionality.
22. Financial Review
Do the company’s financial projections (income statement, cash
flow, balance sheet, AR/AP) go far enough into the future to
show a clear path to profitability?
Are the assumptions that underlie the financial projections clear,
concise, and reasonable ? Do they fit the operating plan?
Do the projections ft with historical financial statements?
Do the margins, growth rates and spending levels match those of
successful competitors?
Are future funding requirements realistic and adequate to provide
proper margin for unforeseen needs?
Will they occur after the company has reached an important
milestone?
23. But wait … There's more ...
Corporate Summary Fact Sheet
Business Plan
Marketing Plan
Key Personnel Resumes
Financial Planning, Cash Flow Model, Analysis Reports
Financial Statements
Profit and Loss Statements
Balance Sheets, Intercompany Transfers
Accounts Receivable / Accounts Payable Aging Summaries
Tax Returns
Asset Ledger
Client List and Actual Sales
Shareholder Statements
Credit and Security Agreements
Minute Book
Summary of Litigation
Non-Competition, Non-Solicitation, and Non-Disclosure Agreements
24. … and more ...
License or Royalty Agreements
Promissory Notes, Bonds, or Debentures
Options or Rights for Capital Stock or Company Assets
Partnership, Joint Venture, or Marketing, Agreements
Material Contracts and Agreements
Cost Sharing Agreements
Contracts or Other Documents Affecting Assets
Development or Technology Agreements and Documents Relating to Business Assets
Corporate Policies (Insurance, Operational, Health, Safety, HR)
Summary of Pending or Proposed Assessments or Tax Liens
Customer and Vendor Contracts
Listing of Sales and Use Tax Returns (All Affected Jurisdictions)
Implementation Plan
25. … Not all problems can be solved with money!!!
Money CAN help you:
•
•
•
•
•
•
•
Write more code
Create prototypes
Test products
Acquire more sale leads.
Build a prettier website
Allow your QA team to improve quality
Give you time to make mistakes
26. … Not all problems can be solved with money!!!
Money CAN'T help you:
•
•
•
•
•
Know what code to write
Know what prototypes to build and test
Know how to convince customers to buy
Know what your website should say or do
Help you know when to ship the product even though it’s
not perfect
• Teach you how to learn from your mistakes
27. A Final Thought …
Focus on reducing uncertainty:
• Emphasize how spending money will improve specific things that are
broken or missing only because money is lacking.
• For those things money can accelerate, show how well you’ve done
and describe how more money will bring more results.
For those things money can’t solve and which you haven’t mastered,
bring it up before the investors do and have a plan.
Show proof of your ability to learn, change, and improve.
If you don’t have a clear, plausible plan, don’t raise money yet.
28. A (final) Final Thought …
The bad versions of “No”:
The silent “No”: You submit a plan, make a call, have a meeting and … nothing
The slow “No”: “This looks very interesting but we would like to see this, this, this and
that.”
The “Yes” that is really a “No”: “We are very interested, but not right now because we
are so busy. Can you come back in two months?
The good versions of “No”:
The clear and fast “No”: They look at your plan, have a meeting, and quickly offer a
specific reason for saying “no.”
The “No” in advance: “We don’t invest manufacturing”, “We only invest in B2C”, “We
only invested in a company that has been referred to us by someone we trust.”
29. Are you ready for Due-Diligence?
Probably not, but don’t worry …
As your company matures you will:
• Generate the information needed to better understand your
market
• Create sophisticated products and services
• Build and manage a great team
• Implement world-class processes
• Create happy customers
And, when the time comes, you’ll be ready!