The Diligence
What do people mean about diligence? I guess it could also be called analysis. Here is the dictionary definition.
(Entry 1 of 2)
1a: steady, earnest, and energetic effort : persevering application : ASSIDUITYshowed great diligence in tracking down the storyworking with diligence to scrub off the paint
obsolete : SPEED, HASTE Go, hence with diligence!— Shakespeare
2: the attention and care legally expected or required of a person (such as a party to a contract)
The second definition is more appropriate for what venture firms do. Diligence is another thing that seems like a total black box. Firm by firm, there is usually a twist to how they do diligence. As firms learn, they might change their diligence process.
There are several layers of diligence. We look at it in terms of sectors, or pieces of the business. When a venture company engages in diligence, typically these are the things that they look at. Feel free to add your own.
Customer Related Data and Documentation:
- Customer reference list
- Customer contracts / Lead Generation contracts
- Partnership contracts
- Pipeline report
- Client list
- Sales structure
- Sales projections
- Sales process overview
Competition Overview:
- Competitor list
- Reports/data prepared and collected on competitors
- How is target market handling the problem currently?
Industry Overview Information:
- Industry / Market reports
- Management market study and focus group reports (if applicable)
- Market Sizing (Current & Prospective) Data / Strategy
- Macro-Trends
- Are there trends from other industries/society that will affect this business?
Product Related Information:
- Marketing materials / documents
- Examples of features / functionalities
- Patents, if applicable
Management Background Information:
- Reference List
- Resume and Bio
- Employee interviews
- Company newsletters
Management Personality:
- Coachability
- Personalility Traits
- Integrity
- Prior Entrepreneurial or other experience
- Sales experience
- How has interaction been since first meeting?
Financial Data:
- Current capitalization table
- Financial statements
- Budget and financial forecasts (including statement of cash flow)
- List of outstanding option holders and associated option agreements
- Warrant / Loan agreements
- Bank statements
Operational Data:
- Compensation plans
- Employee offer letters and agreements
- Employee policies
Legal Documentation:
- Proposed term sheets from other investors if there are any
- Articles of incorporation and by-laws
- Any Non-disclosure agreements
- Any previously negotiated term sheets with terms
- Any disclosures that are not apparent, side deals, stock allocations promised
Obviously, there are a lot of permutations to the process. It helps if entrepreneurs set up a data room that has a lot of this stuff in it. That limits the amount of communication back and forth between the two parties so that the entrepreneur has more time to concentrate on executing the business.
Fundraising is always a distraction.
There are other questions that firms might ask. For example, our firm prefer companies that can become platforms, not just a tool that is bought. That requires the entrepreneur to pitch us the long term vision and the potential path to get there since most of the time businesses don’t start off as full blown platforms. They find one entry point, and then expand.
Of course, at seed it all comes down to the team. If the team can’t execute, it doesn’t matter how great the idea is or how big the pain point is. Sometimes at seed, it makes sense for the firm to introduce the existing team to potential new team members. I know of some companies that came out of universities where the investor loved the idea and found a CEO to lead it because the existing team while smart didn’t have the business execution skills to operate the business.
Source: http://pointsandfigures.com/2018/12/06/the-diligence/
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