Aspects of Due Dilligence

Due diligence is the final stage in a long investment process, so it's unlikely much can go wrong at this point, right? Wrong - but there are steps you can take to tip the balance in your favour and using the latest business plan software technology will support you with this process.

It's an entrepreneur's worst nightmare. You've given countless presentations and sat through endless meetings with VCs before finally getting a terms document from an interested investor. Then, as due diligence is carried out, the VC's advisors find out a 'dirty little secret' about your company that throws the whole deal into jeopardy.

For many organisations, due diligence is seen as a difficult and time-consuming exercise that caps a stressful and exhausting investment process. But there are a number of steps you can take to help the process go more smoothly, and with the right preparation you can even short-circuit it. Preparation means just that - in many cases, the documentation you will need to present to investors will stretch back over years, so it's important to keep everything up to date as your business grows.

To begin with, keeping secrets of any kind is a singularly bad idea when you're dealing with current or potential investors. 'VCs hate surprises,' says Keith Arundale, author of the British Venture Capital Association's Guide to Private Equity. 'If there's something that's significant to the investment and you don't disclose it until the due diligence stage, that's going to be a problem.' Arundale advises entrepreneurs to outline anything they think might be of the slightest relevance up front and update investors on any new developments in a disclosure letter. Mike Bowman, investment executive at g2i partner company eSynergy, adds that holding back early on may come back to haunt you: 'What you may perceive as a problem may not be a problem to the investor. Problems aired early can be dealt with. Problems uncovered by the investor towards the end of due diligence may well halt the deal.'

Richard Anson, CEO of Reevoo, the on-line reviews service, is even more categorical. 'Honesty is not just the best policy, it's the only policy - there is no other way.'

Reevoo secured $5m from Eden Ventures towards the end of last year to expand its services and tackle new markets, both geographical and vertical. Anson found the due diligence process relatively painless precisely because of the way the company had prepared, beginning with its documentation. He points out that these documents include contracts with customers, suppliers and partners; details of intellectual property (IP) rights; the technology in use at the company, employee service agreements; compliance with relevant legislation; information about key processes; and insurance documents. While the company's advisors may be presenting this 'bundle', it's important to remember that it's the directors themselves who are signing off on it, including providing warrants. The most common example of a warrant required by a VC is to the fact that there's no outstanding litigation against the company, but an investor could ask for warrants about any verbal statement you might have made that if untrue, would affect its investment position.

Equally from the VC's perspective, due diligence is just the final stage in an investment process that starts with an initial application, runs through presentation meetings and deal assessment, includes negotiations over deal structure, and proceeds to approval, offer and completion. At each of these stages, the VC will be screening the prospective investee on different aspects of the deal - 'peeling the onion', as some due diligence experts refer to it - which minimises the formal work that needs doing at the final stage and reduces the risk of surprises.

Arundale, who is about to publish a more in-depth version of his private equity guide in book form called 'Raising Venture Capital Finance in Europe', says: 'Once they've seen business plans or an exec summary and met with the team, the VC will already be carrying out their own informal due diligence enquiries, and they'll do this to the point where they're interested in making the initial offer. It's only once that's in place that they go about the more formal due diligence.'

Questioning assumptions

So what exactly does due diligence cover? The areas entrepreneurs usually think about are the financial figures, including evidence supporting the assumptions that underpin the company's projected growth. But investors will also be looking hard at the business opportunity, the quality of the management team, the technology behind the product and various intangibles, such as the IP. Often external consultants will be brought in to examine these different areas.

eSynergy's Bowman says that as much as digging into the details of the product, due diligence is designed to test the responses of the management team. 'It's about getting to know the company they are investing in and how they deal with the issues raised. This is just as important as the details of the plans and markets, as the team is the most important aspect of any investment.'

One of the most difficult areas for potential investors to judge is market positioning, particularly in emerging technology sectors where it's tough to assess how large a slice of an emerging market you can take. Real customer references - or agreements in principle to make purchases - are the favoured evidence here. But VCs might also bring in technology experts - perhaps from a University department with a particular specialism - to examine the technology opportunity. 'It can be difficult assessing the size of the market, particularly if it's a new technology,' agrees Arundale. 'Maybe the VC will have to carry out new market research about whether people are actually going to buy the technology. There's no point in having fantastic new technology if no one's going to buy it.'

Given how exhausting that process is, you might assume that any unsavoury issues will have been eked out long before you get to the due diligence stage. But not necessarily so, says Arundale. Business changes fast, and during an investment process lasting six to nine months, much can happen. Typical problems include the day-to-day risks that every business faces, such as a big customer contract falling apart at the last minute - which is not unusual, and not necessarily a dealbreaker. More serious problems are rarer, but they can happen. One due diligence advisor, examining a company that had been approved for investment by a VC, found most of its R&D work going through a partner in Dubai. That breached the rules of the government-supported funds that the company was relying on, which require any investment to benefit the UK economy.

Finally, some entrepreneurs are concerned about giving away confidential information to investors, fearing they'll use the information to help their existing portfolio companies. It's difficult to say whether these fears are well grounded, but there are measures companies can take to allay them. Some VCs will refuse to sign non-disclosure agreements upfront, simply because too many ideas cross their desks, but many will do so as discussions progress - the BVCA, for example, provides a confidentiality letter template which its members should be willing to sign. An alternative approach, Arundale adds, is to ask to deal with a different investment executive at the VC firm to the one who's already made investments in your competitors. Ultimately, however, there has to be a certain amount of trust in any business relationship, particularly when you're dealing with reputable firms. 'Hopefully they are people of integrity and trustworthy, so it shouldn't be a major issue,' he says.

By David Longworth, Webster Buchanan Research

Keys for managing business risk

Why would a large, well-established company gamble everything by purchasing business-critical technology from a start-up?

When Christopher Crowhurst signed a contract with a specialist software developer in the fast-emerging field of web services, it was the end of an exhaustive selection process and the beginning of a slightly unusual supplier-customer relationship.

Crowhurst's company, computer-based assessment provider Thomson Prometric, had spent 14 months assessing its technology options before deciding to put its faith in the start-up software vendor, Actional. As vice president and principal architect, Crowhurst knew Thomson's fortunes - and the success of a strategic $5 million IT project at his company - would become inextricably tied to the vendor's viability. Success wouldn't just be down to functionality, implementation skills, technical prowess and the other factors involved in making any IT system operational - it would also be down to the supplier's ability to sell the same system elsewhere and so stay in business. And although Actional, a specialist in Service Oriented Architecture technology, has since notched up multiple live customers, at the time he began the selection process no referenceable customers were in production.

Crowhurst's informed gamble on Actional was an extreme but telling example of the factors that come into play when companies purchase strategically-important technology from small, relatively young vendors. In any market where much of the pioneering work is being carried out by venture capital-backed specialists, organisations that require bleeding-edge technology have to take two tightly-connected risks. Firstly, they need to be sure that the technology is stable and does what it's supposed to do - and secondly, they need to know the vendor will be around for long enough to keep on developing it. Larger vendors inevitably seize on this issue, so helping purchasers take steps to mitigate risk could be the difference between a start-up clinching and losing a sale. That's one reason why two staple components of any specialist vendor's marketing presentations are updates on the latest round of funding and a run-through of new customers.


What Crowhurst and others have done is push back the boundaries of the research process typically undertaken by customers prior to making a purchase. Beyond addressing features and functionality, most tech start-ups would expect their sales prospects to do some kind of financial due diligence prior to making a strategic investment. But it may not stop there. They may also want to meet the supplier's finance director and its venture capital backers, and check the composition of the board to ensure it's got the right balance of VC, strategic, financial and operational input. One customer that made a similar purchase to Thomson also drilled down into its vendors' middle management and engineering capability. This should all connect back to a strong visionary - getting a company with committed founders and a CEO who's passionate about the organisation, not just treating it as their next job. In addition, the start-up's technology and marketing partners will also be a factor.

Crowhurst suggests that the level of commitment shown by key individuals within the vendor company can be measured in several ways. He believes in spending face time with key players from the CEO down - in fact, he spent three days at Actional's headquarters, part of what he believes is a vital process to get beyond the salesperson. 'I developed a relationship with the CTO of Actional and have managed to influence development of the product - with some other organizations, we couldn't get beyond the sales folks,' he says. 'You need to get to the engineers, feel you can trust them.'

But he also argues that suppliers give much away by their own actions (or lack of), pointing to standards bodies as a good example. It's not enough for an organisation to be in a standards body - it's about being engaged in the body. Crowhurst subscribes to a number of standards bodies' newsgroups, which gives him insight into which organisations are active within the body, rather than merely taking up membership because they feel they ought to.

The flipside of managing the risk associated with a start-up is that there are many positive reasons for buying from a smaller business. For one thing, it's the smaller specialists that tend to set the pace in emerging technology sectors, leaving larger vendors playing catch-up. In addition, they can offer a different kind of purchasing experience. James Brewis, managing director of expenses management vendor Signifo Expenses, points to a deal his small London-based company won against a large US rival. 'On our side there was the usability, the greater speed and lower cost of implementation,' he says. 'On their side was all the bells and whistles functionality and the fact they were an established player with significant revenues.' The customer believed that the former offset the risk. 'As a business owner and an entrepreneur, you've got to be prepared to get in there and ask the customer to take a chance on you - to tell them you'll do everything in your power to meet their needs and ensure the highest level of satisfaction,' says Brewis. With local, London-based sales and support, he also believes he can provide a level of service and focus that some global players may struggle to match.

Inevitably, the process of winning over customers is time-consuming. Even after selecting Actional, another six months passed before the deal was signed as Thomson's internal team set out to convince the corporation that it was the right decision and developed the financial justification. During that time, several other Actional customers went into production, which helped boost confidence. Crowhurst's team also documented a back-up plan during its internal capital approval process in case of problems: because Actional uses a standards-based platform, the team was able to demonstrate that it would be fairly straightforward to take the Thomson configuration and implement it on another platform.

Ultimately, however, winning over this kind of customer may have benefits that go beyond mere revenue. 'I have an interest in [Actional's] success,' says Crowhurst. 'I promote the project quite ferociously - I need other people to buy into the technology. I'll gladly be an advocate - they're a great organization and I've worked with them extensively.' Deeds speak as loudly as words, and the fact that customers have tied their fortunes to a particular vendor for strategic projects is an important vote of confidence.

This article is developed from a feature that originally appeared in 'Loosely Coupled's Monthly Digest', a subscription-based newsletter offering in-depth reporting and analysis for early adopters of SOA and business process automation.

Customer is King

Struggling to manage your sales data is the kind of 'problem' most start-ups would die for - at least it means you have customers. But even in the earliest part of the sales cycle, capturing and analysing customer data could prove critical further down the line.


If your sales team's idea of information management is to log their prospects' contact details in a spreadsheet and file client business cards in alphabetical order, it might be time to introduce them to some of the newer techniques that have become possible over the last few years. Even if your biggest problem today is getting early proof of concept sales, keeping a grip on all the relevant information quickly gets problematic once your business moves out of the development stage, particularly if you're in the consumer market or have a dispersed prospect base. It's not just about better administration - for some companies it's about cutting the cost of doing business and increasing the chances of clinching deals.

Even in the software-savvy hi-tech sector, sales automation software has enjoyed something of a mixed reputation in the past, particularly among more experienced sales professionals who rose up the ranks using little more than a Rolodex system and pen and paper. Some people still tend to think of it as a computerised contacts list and wonder what the fuss is all about - this, after all, is why personal organisers were invented. In smaller start-ups, where even the most mundane sales-related information tends to be shared with everyone on the team, the idea of purchasing a system to record sales data seems like overkill.

At their most basic level, however, sales automation systems provide security for a key asset - customer information. How much of your sales information will walk out the door if your sales director misses target once too often and decides to try their luck elsewhere? Do you know what your customers and prospects are telling your team about their future purchasing plans and product needs, and do you have a grip on all of the sales objections they're coming up with? How easily can you get a snapshot of ongoing sales activity and assess the strength of the prospect list if one of your investors calls for an update? And can you measure how effectively your sales team is working - how many calls are getting through; how many face-to-face meetings they're setting up; or how long they're taking to close each deal and what its value is?

This kind of information is routinely captured in sales automation systems, which bring a combination of process control and business intelligence to the whole sales set-up. At an operational level, sales systems bring a degree of administrative efficiency as the volume of prospects increases, providing templates for commonly-used documents and alerts for follow-up calls. They also give salespeople easy access to details of past conversations with prospects and customers detailing their business pain points, IT budgets, previous objections, competitive data and so forth. Managers of larger sales teams can also use the functionality to control leads centrally, which speeds up processing time in high-volume environments and allows organisations to allocate leads more effectively. Some sales systems also provide insight into marketing effectiveness: after running different campaigns, leads can be allocated to their source to see which approaches delivered the best return.

But it's in the field of business intelligence that sales automation promises the most significant long-term benefits, particularly for small business managers who tend to spend more time finding and collecting information about their business than actually analysing and acting upon it. The greater the analytical capability that's built into a system, the more powerful it will be. Because sales effectiveness is so critical to a business as it moves out of the development phase, there's often an assumption that management will already know the most important details, but it isn't always easy to take a step back for trend analysis. Analysing sales activity quarter on quarter, for example, gives you an additional perspective on current performance. Likewise, forecasting becomes more reliable if you have a rich historical context; if past records show that lead times in certain business sectors are long, that may influence your estimates as to when sales will close.

Many of the largest sales automation software vendors now provide this kind of capability for smaller businesses. They include Sage, which sells several applications including ACT! for small business and Saleslogix for mid-sized companies; Salesforce.com, which hosts sales software remotely for users to access over the Internet; and Siebel Systems (currently being acquired by Oracle), which was the leader in customer management software at the enterprise level and has more recently targeted the SMB space. As a measure of pricing, Salesforce.com offers packages starting at �45 per month per user, or �690 for five users.

There are of course some caveats. Firstly, like all user-based pricing, the monthly bill or package licence fee will go up as the volume of users climbs, something that's particularly worth bearing in mind in sales automation where access may be required from multiple departments. Secondly, it's important to establish how flexible the system is in terms of searching and slicing and dicing information: it's all but impossible when you first implement a system to know what kinds of reports you'll want one year down the line. Ease of integration will also be a factor in the future: for example, some organisations link sales to credit control to ensure sales staff are up-to-speed on accounts that are on credit stop.

Most importantly, as with any analytical exercise the quality of the analysis will depend in large part on the quality of the raw data - and that data is generated through day-to-day use of the system. If you really want to have strong historical insight into your sales effectiveness, the earlier you start collecting data the better.

By Keith Rodgers