Preparing the right documents, filing them correctly, or knowing what to look for can be a challenge for most; but we always tell our clients that conducting due diligence is like receiving free legal advice, especially useful for young and emerging start-ups. Consider it a cheap way to learn a little bit more about how to run a company.
For investors, it is essentially checking out the product before making a purchase, or test driving the car before buying. Professionals come in and gather information on the product/service, the founders and the team, and report their findings to the investor. For the founders, due diligence gives invaluable insight into what they need to do, or changes and improvements they need to make to satisfy investors. From a corporate due diligence perspective, it can highlight what documents or records their company is missing. From an IP or employment point of view, companies can learn what type of arrangement investors expect, how their IP rights should be properly protected, and what provisions should be included in employment agreements.
Technology-based start-ups need to navigate through a plethora of laws and regulations wherever they do business. They may be overwhelmed with the amount of red tape they have to go through, but having an investor conduct due diligence could be considered an ideal opportunity for them to identify what they are lacking and what risks their business could potentially be facing. While governments pass laws with large institutions and corporations in mind, start-ups are often left with the daunting task of playing catch-up and internal resources may not be allocated correctly. As a result, it is not surprising that a number of emerging companies are non-compliant with regulations.
For corporate VCs, their focus and scrutiny may be shifted to areas other than valuation or potential growth, as is the case for pure VC funds looking for capital gains. A corporate VC will secure investments for a number of reasons, but a main driver for them is being able to secure access to new innovations and technology early on. This is so that they can actively monitor and dictate product development. For corporate VCs, the prospect of integrating and synchronising the technology and/or product into their existing product/service line is more important than the financial return that investments may offer. As a result, we often see a lot of focus during the due diligence process on Key Performance Indicators (KPIs), the regulatory framework and licenses and permits.
We also often see corporate VCs making investments in order to build a relationship with the start-up to act as a strategic partner rather than a typical investor. From a start-up’s perspective, this is like hitting two birds with one stone – you are raising funds as normal, but you are also gaining a strategic partner who has an existing large established client base; and this new resource can grow the valuation of the start-up substantially.