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The Thorough Approach to Due Diligence

3 min read  The Thorough Approach to Due Diligence. A startup investment goes through a series of stages. The first stage is the pitch presentation, in which the startup introduces the deal to the investors. Next comes a follow-up meeting where the investors can dig in to learn the details. After this meeting, investors typically take time to think about the deal and observe the startup as they continue to make progress. The third stage is the due diligence phase. In this phase, investors review the startup’s documents, team, and market thoroughly. If the terms sheet has been established by other investors, the investors review those documents. If not, the investor will negotiate the terms- including valuation. This article will look at the due diligence phase in detail, outlining how to perform a thorough diligence approach. The Thorough Approach There are several approaches to due diligence. The most common is the “Thorough Approach. ” In this process, you review each aspect of the business and focus on the top items. The main areas to cover in due diligence are: Market What’s the market size (total, serviceable, beachhead?) How fast is it growing? Product What is the state of the product, both technical and market? Does it solve a burning need or add a general value? What has actually been developed? What remains to be developed to go to market? Who has used the product, and what do they say about it? Legal What contracts are in place? Are there any lawsuits? Intellectual Property What patents have been filed/approved, and when? What trade secrets do they have? Financials What revenues have come in? What financials are pending? What is the burn rate? Capitalization What is the capitalization structure? Who are the major players? People Who are the key players, and what are their roles and responsibilities? What contracts are in place with each key player? Market Due Diligence As an investor running due diligence on a startup, the key issue to focus on is the size of the market- the larger the market, the greater the growth potential of the startup. Luckily, there is rarely a need to pay for research since so much exists on the web. In searching the web, you’ll find research reports giving market sizes, trends, analysis, and more. The key is to analyze the market at three levels: Total Available Market: Anyone the company could ever sell to Serviceable Market: The target market the company wants to serve Beachhead Market: The first niche the company will pursue Ideally, the beachhead market would be a small yet well-defined group of companies that fit the startup’s current product. It doesn’t necessarily need to be the biggest or most lucrative market but rather the easiest to pursue. The startup should already have some interactions with the companies in the Beachhead market. Team Due Diligence The team is the most critical factor for an investor to analyze during the due diligence process. Since the startup likely has only a nascent product and some intellectual property, the team is the only thing that can really be dug into. First, the investor team should review the resumes of those who are on the team or plan to join when funding becomes available. Placeholders of ‘We’ll look for someone later’ is a red flag. The CEO should know who they are planning to bring on. It is also important to find out how long the team has worked together and if they even have worked together in the past. Next, look for domain knowledge: Who has it, and how current is it? Investors should also look for complementary skills. For example, if there is a team member who has complementary sales skills, will they spend their time selling the product? Or will the person who will build the product manage an internal development team? This question is still valid even if the startup is choosing to outsource. Outsourcing product development with no one actively managing it is a recipe for disaster. Finally, look at ‘completeness’. Many successful teams follow the Designer, the Hacker, and the Hustler formula. The Designer knows the customer problem and plans the product development, including how it will be monetized and promoted. The Hacker is the developer who builds the product, and the Hustler is the one who sells it. Does the startup you wish to invest in have a formula? Quantitative vs Qualitative Due Diligence There’s a quantitative side and a qualitative side to due diligence. The quantitative side includes checking the list of documents in the data room to verify the accuracy of those documents. For example, Do the entity filings match what the company claims to have? Do the intellectual property documents match what they claim to have? The qualitative side of diligence includes evaluating the team and the growth prospects in the market, sizing up the competition, and predicting the company’s ability to execute. Somebody should do the quantitative side with industry experience as it requires more discovery. An analyst or assistant can help with the phase.   Read More from TEN Capital Education here. Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

The Due Diligence Process

2 min read. The Due Diligence Process When embarking on a new investment, it’s essential to have a Due Diligence process in place to check the basics. This process will vary from deal to deal based on the risks associated with each one. Start by making a list of your concerns. In most cases, you’ll sign a terms sheet with funding contingent on due diligence. It helps to tell the company about your diligence process, such as what documents are required, what steps you take, and how long it will be, thereby eliminating the “how is it going” calls. There are three phases to diligence: Documentation Diligence, Team Diligence, and Domain Diligence. Documentation Diligence Ask the startup for a list of critical documents. If they are not all in one spot, ask the team to put them into a Google Drive folder or create a more secure Box.com account. It’s common for startups to continually add to their diligence boxes and have many people view them simultaneously, so keeping everything in one place is very helpful. The primary documents should be: Entity filings and articles of incorporation Patent filings Income statement Balance sheet statement 3-5 year financial projections Cap table Other documents related to the business, such as lawsuits, product breakdowns, customer breakdowns, etc., should be requested. Read each document and check to see if it matches what you understood about the deal. Note any differences and ask for clarification. You must review the diligence documents so you understand the business. You may need to sign a Non-Disclosure Agreement (NDA) for sensitive information. It’s standard practice to do so, as the documentation should be kept confidential, even without an NDA in place. Team Diligence Thoroughly researching the startup’s team is the most critical part of the Due Diligence process. Meet with the team and assess their skills. In almost every startup failure, the investor can trace it back to the team not being up to the task. It may be the task was underestimated by all upfront, but with the right team, the company can succeed. Gather references for the CEO and call them up to hear what they have to say about the founder, including management style, how they pivot, and their team dynamics. In most cases, you’ve heard the CEO pitch, but it’s essential to understand the CEO’s skill set, including what is there and what is not. The rest of the team needs to bring the necessary skills to succeed. Domain Diligence Let’s break this process down into steps: Research the competition to determine the company’s position in the marketplace Check the positioning of the company in the marketplace Identify the value proposition and how well it resonates with customers Look at their pricing compared to the competition Check the industry to see the conditions in which it will grow or decline Once you finish your diligence and have your questions answered, ask for their wiring instructions Remember, break it down into baby steps Finally, use the model of “fast no’s and slow yes’s” in reviewing a deal so the entrepreneur is not chasing you for a response.   Read More TEN Capital Education Here Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

The Due Diligence Process

2 min read. The Due Diligence Process When embarking on a new investment, it’s essential to have a Due Diligence process in place to check the basics. This process will vary from deal to deal based on the risks associated with each one. Start by making a list of your concerns. In most cases, you’ll sign a terms sheet with funding contingent on due diligence. It helps to tell the company about your diligence process, such as what documents are required, what steps you take, and how long it will be, thereby eliminating the “how is it going” calls. There are three phases to diligence: Documentation Diligence, Team Diligence, and Domain Diligence. Documentation Diligence Ask the startup for a list of critical documents. If they are not all in one spot, ask the team to put them into a Google Drive folder or create a more secure Box.com account. It’s common for startups to continually add to their diligence boxes and have many people view them simultaneously, so keeping everything in one place is very helpful. The primary documents should be: Entity filings and articles of incorporation Patent filings Income statement Balance sheet statement 3-5 year financial projections Cap table Other documents related to the business, such as lawsuits, product breakdowns, customer breakdowns, etc., should be requested. Read each document and check to see if it matches what you understood about the deal. Note any differences and ask for clarification. You must review the diligence documents so you understand the business. You may need to sign a Non-Disclosure Agreement (NDA) for sensitive information. It’s standard practice to do so, as the documentation should be kept confidential, even without an NDA in place. Team Diligence Thoroughly researching the startup’s team is the most critical part of the Due Diligence process. Meet with the team and assess their skills. In almost every startup failure, the investor can trace it back to the team not being up to the task. It may be the task was underestimated by all upfront, but with the right team, the company can succeed. Gather references for the CEO and call them up to hear what they have to say about the founder, including management style, how they pivot, and their team dynamics. In most cases, you’ve heard the CEO pitch, but it’s essential to understand the CEO’s skill set, including what is there and what is not. The rest of the team needs to bring the necessary skills to succeed. Domain Diligence Let’s break this process down into steps: Research the competition to determine the company’s position in the marketplace Check the positioning of the company in the marketplace Identify the value proposition and how well it resonates with customers Look at their pricing compared to the competition Check the industry to see the conditions in which it will grow or decline Once you finish your diligence and have your questions answered, ask for their wiring instructions Remember, break it down into baby steps Finally, use the model of “fast no’s and slow yes’s” in reviewing a deal so the entrepreneur is not chasing you for a response.   Read More TEN Capital Education Here Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

Due Diligence Box: What Is It and How to Prepare One

2min read Due Diligence Box: What is it and How to Prepare One After an investor expresses interest in funding your deal, the first question to ask is: “What is your diligence process?” Having a due diligence box with the standard documents helps a great deal. It shows you are prepared and typically only requires minor additions for each investor.    The Due Diligence Process While most diligence processes follow the same document review and analysis format with a round of follow-up questions, each investor has their own start time, work timeframe, and specific documents they look for. It’s best to ask for their process, and then follow along with it. If the investor does not have a specific process, then presenting the due diligence box should be enough. For new investors who are not sure what to do, you can offer to walk them through the diligence document by showing them all the relevant information. It can be helpful to contact the associate or analyst who will be doing the detailed work and open a direct line of communication with them. By building a rapport, you may contact them directly for progress status and updates. You can also position your calls as opportunities to answer questions and to help the associate find specific pieces of information. Investors are busy and can get drawn away by other deals, so it’s important to be timely with your follow-up. Having a due diligence box with the standard documents greatly helps with this. It shows you are prepared, and typically only requires minor additions for each investor.   Due Diligence Box In preparing a due diligence box, also called a data room, there are basic documents to include. These documents consist of:  Income Statement and Balance Sheet 3-5-year Financial Forecast Cap Table- including shares outstanding Entity Filings including Articles of Incorporation Intellectual Property Filings- including patents, trademarks, etc. C-level Team Resumes  There may be other documents you may need to add based on your situation.   Reps and Warranties Contract One document that is helpful but not required to include in the due diligence box is a reps and warranties contract. Information taken in by investors about a startup’s product, team, financials, revenue, and more can change rapidly during the startup phase of the business. One method of assuring the investor the information provided is true and accurate is for the startup to sign a Reps and Warranties contract. This is often tied to the diligence provided.   This contract states that everything provided in the diligence is true and accurate and that no material has been omitted. If it later turns out that there’s a material difference between the business and the diligence, then the Reps and Warranties contract provides legal recourse to the investor for recovering any damages. For example, if the financial statements indicate there’s no debt in the business, then the investor assumes the business is debt-free. If the startup does in fact have debt, then the investor can take legal action against them.  Some investors demand such a contract to be signed to ensure they have the full picture of the business. Signing a Reps and Warranties Contract can strengthen a startup’s case on the diligence provided.   Read More TEN Capital Education Here Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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