Author: Dr Sunil Shekhawat is CEO of SanchiConnect & Ex Head of Products (DeepTech Club) at NASSCOM
The purpose of the investments is to grow your wealth and this mantra plays equal to both individuals and institutional investors. When an individual discover opportunity to invest, be it real estate or mutual funds or equity, there are certain checks that he/she want to ensure which reduces the risk of failure. Having said that with every investment, there is an varying inherent unavoidable risk of capital loss.
Similarly in an institutional investment especially a startup which has been in existence for not very long hence have lesser available data points to compare, the risk of failure is even higher. People still opt to make startup investments because the returns here follow different maths than any other investment instrument. This makes the due diligence (dd) more important and specialized which need distinguished data and skillset.
A Venture Capital fund or an angel network has comparatively a larger accountability verses individual angel since they deal with someone else’s money. A series of bad dd’s can raise existential questions on them. Hence the process is attempted to be made as air tight as possible by the representing party which might sound terrible to a startup founder. This is actually a non-escapable gateway if you intend to raise money from equity funders.
Here is a guide to help deep tech startup founders to be better prepared for future events which at times can become make or break in fund raising. Being aware of these from day 1 will ensure strong foundation for future dd compliance
Business due diligence
Business dd largely remains same for tech and non tech business. These largely ensure the team is tapping the right market opportunity and has the grit to sustain leadership
– What is the overall opportunity size vs you are tapping or planning to tap
– MOAT, your capability to maintain competitive advantage in future
– What does your suppliers, vendors and customers think about your prospects
– What kind of t&c applies to business / channel partners, do they have exclusivity, what grounds have been used to define these partnerships, how are they linked to business growth
– What are the current contracts in existence, why are they alive vs those which got terminated in past, what percentage of them are doing well vs not doing so well, definitions being used in classifying them
– How have you safeguarded company’s and director’s interest in business contracts against any kind of bankruptcy
– Satisfaction quotient of business partners, what is making them stay with you today and for future
– Business orders in pipeline and the likelihood of surprises
Legal due diligence
These include the legal risks a VC / investing partner will be going through in partnering with your company. These are reviewed through the documentations produced of past.
– Any litigation that the directors or founders or the company is facing. Many a times this goes into much detailing depending upon geography of your business operation’s presence
– MoA, AoA, prospectus and compliance certificates which defines the purpose of existence of your company
– Board meetings, AGMs documentations, decisions taken and filings of the same
– RoC compliances, settlement letters addressed in past
– In case of startup dealing with sensitive / strategic sectors, the certifications, disclosures, licenses from competent authorities matter a lot
Technical / Intellectual property
This involves assessment of technical assets like software, hardware, copyrights and intellectual property (if any). This function is carried out by experts of respective technology only.
– Includes technology evolution plan, roadmap for near and long term
– Any possible infringement, comparison and competitive edge over other players
– Status of IP, filed or granted, in which geographies with logical reasons, documentations
– technical scalability of product
– assessment of areas like engineering org structure, programming languages, technological integrations, data centers, databases, APIs, applications
Financial due diligence
This entails examination of financial books and data.
– Audited P&L statements of the last 3-5 years or less in case of young entities
– Generally carried out to make sure the income, expense are in sync with what is being presented initially and claimed
– This gives confidence to the investors on the capabilities to reach closest or surpass the projected numbers in subsequent years
– Revenue growth in MoM, QoQ, YoY formats for comparison in series to derive trends
This helps determine the financial health of the company and desperation founders are hiding
– Liabilities and assets are evaluated on both quality and quantity scale
– Bills, discounts and the logic behind to eliminate possible bias
– Past, current and future tax liabilities
– Documentations around order and booked values, Purchase orders under pipelines, debts and the status of repayments
HR due diligence
This a wholesome process which start from day 1 and continues till the money actually gets visible in company account. This includes
– founding team’s credentials, professional / educational that proves their ability to execute the business on ground
– Ownership distribution both equity and roles & responsibility based
– Mentors, advisors and their role
– Senior leadership which serve founding team and their motivation to stay longer with company
– HR policies and their alignment with applied labor laws
– Employment contracts
– Grievance addressal system, how complaints have been handled in past
– Attrition, reason, how efficiently founders have handled it
These are the external factors capable of deviating desired outcome of the investment planned
– Existing govt policies – conflict or supportive to the business under consideration
– Possible future implications as the journey moves ahead
– Possibility of encounter with non-competing businesses of today to throw threats
– Geopolitical implications / dependencies
Any investor be it a VC or an individual will prefer picking up deals with some alignment with their core business or philosophy / thesis of investment. Luckily, this is the first filter an investor would use before investing time. Only after seeing a short or a long-term fitment, conversation is taken to the next level.
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