“Founders don’t do the diligence they should on their investors. Entrepreneurs should pick their investors like they pick their co-founders: very carefully.” – from Sabeer Bhatia’s Interview
The term due diligence is used when a company decides to investigate and gauge the value and use of a business opportunity such as a merger, investor and other such prospects. Due diligence on investors also therefore is an absolute must as this exercise would explore and analyse the potential investor from all aspects and help the company decide its future transactions with them in a planned and meticulous manner. Due diligence on investors may seem like a complicated and cumbersome task but just like all other business practices, it is an exercise that is a must do. It is the groundwork and solid backing required by any company to make a sound investment and avoid any unnecessary risks, in an already competitive business environment. Through the due diligence of investors or any other potential business partner, a company is able to gain confidence that the ‘partner’ is who and what they appear and also whether there are any potential damaging risks in being in the partnership.
Due diligence on investors is every company’s right and is also a common-sense and practical approach to doing business. One can never be too careful in business. There is no basis for the belief that only investors can or should conduct due diligence on companies. Complete clarity and honesty is required for both parties and unless the other has something to hide, no one will take offence to the due diligence rigour. Each company / business owner has the responsibility to ensure that they do everything required to make a business deal successful and also protect their interests – due diligence on investors is just a part of this mind-set and set of accountabilities. This exercise will help both parties to understand whether the ‘deal’ is worth taking the time and making the effort and also indicates to the investor, that the company is professionally run, meticulous and is serious about growing and helping the ‘partner’ to grow.
Why do you think that some companies ignore this task or only skim through the process? It could probably be because due diligence is a cumbersome and awkward process and tends to be prejudiced towards the company conducting it. However, despite these aspects it is a crucial, necessary and important process and instils confidence and discipline in the entire process of investing and receiving. A company’s business could be depending on the partnership and hence it is better to be ‘safe than sorry’ and any investor, worth his salt, will fully cooperate in this process and be willing to provide any information required. The fact is that due diligence on investors is essential – they are about to become a partner for a long time in your business and given the volatile nature of the business environment it is your right to do everything possible to ensure that the partnership does not go awry.
When an investor agrees in principle to provide capital to your company, they too conduct a thorough investigation on your potential risks, liabilities and possible weaknesses. It is a taxing time for any company. The company too has a duty to engage in due diligence on investors (remember to scrap the plan if the potential investor resists this process on your part). Most investors now – whether they are venture capitalists (VCs) or angel investors – would have information about themselves on-line that would be easily accessible to the company to facilitate the decision making. Have you ever conducted a due diligence on investors – what steps did you follow and how was the experience?
It is important to first and foremost visit the ‘face’ of the VC / investor. This would provide a clearer picture on the experience and the kind of projects been funded by them and whether the industry of which your company is a part has been a recipient of funds. A proper understanding of your industry on the part of the investor is crucial for the relationship to work long term. The investor would also know what to expect and the kind of returns that can be gained and by when and hence there would be no ambiguity or unrealistic expectations on either side.
With the information got on the prospective investor, a company must contact the persons that the investor worked with earlier. As part of the due diligence on investors, getting data off people with whom the investor was involved will provide experiential data that the company can use to their advantage. There are many unbiased resources on the internet that provide investor reviews which help companies make informed decisions. In addition, a company could also get in touch with other investors to get a ‘feel’ for the potential investing partner. It is important though, to weigh the opinions and feedback from this group since there could be some biases and prejudices involved – but even then the feedback provided would still be vital.
Seeking advice and recommendations from other business owners must also be part of the due diligence on investors. If they have worked with the investor or know anyone who has, the information received from such sources would provide a solid foundation for the association that is to happen. Analyse all the details and evaluate the pros and cons for your business before going ahead with the partnership.
It would be a good idea to interact with the potential investor in a relaxed and off-business environment. This will help the company to understand whether the mind-set of the investor matches their own and whether the relationship will be a pleasant and fruitful one. Common interests such as social responsibility are a good way to build rapport and connection. In addition, building a relationship is important also from the context of both companies getting to know each other. This way, even if the contact persons of either side leave, the relationship will continue uninterrupted.
Once all the investigation seems to have been completed, the next step is usually an agreement between the company and the investor. This agreement must be in writing and must clearly state the expectations, guidelines, regulations and conditions of the relationship. All the clauses and terms must be properly defined and completely agreed to in writing so as to avoid any ambiguity and confusion later on. Ensure that the terms and conditions are not overly aggressive and intrusive as this could be a sign of mal-intent on the part of the investor.
In the event that the investment is from offshore, even more caution must be exercised as it would harder to find out the source of the funds. If the adequate and required clearances are not in place, the company could find itself in an awkward and embarrassing position and even could be forced to return the funding. Insist on all the details and completed paper work for the clearances so that you are leaving nothing to chance.
The whole due process of diligence on investors may seem overly cautious, but keeping your company safe is your responsibility. It is becoming increasingly hard to raise money and sustain liquidity and so an offer of a substantial cash inflow could be highly tempting. It would be wise to exercise restraint and caution and take your time before entering into an investor-business owner partnership. This is a crucial decision and hence it is important that a company is completely satisfied and at ease before making it. If the process due diligence on investors reveals unsettling facts and leaves a company with a feeling of uncertainty, it is best that this relationship is not formed. Move on to exploring other partners and options.
