Preparing for due diligence
Due diligence is where the investor will take a closer look at a business and work out what they think it’s worth, and whether the business is worth investing in. Don’t be too alarmed if investors start checking on your claims in your proposal. But do realise they will also be checking out other aspects of you or your business that you might not be aware of.
Don’t be surprised if, for example, they check your background for any past bankruptcies, criminal convictions, or outstanding debts. They’re also likely to ring those references you listed or mentioned, and perhaps even check on the referees! If any larger business is going to give you substantial money (like a few million), then it’s their right to make sure their money is safe.
On this page:
- Preparing for due diligence
- What will be investigated?
- Why are these steps necessary?
- The importance of legal protection
Preparing for due diligence
If you have had a failure somewhere in your past, then be upfront and try to turn it into a positive by letting people know what you learnt from it. The key to preparing for a due diligence assessment is to make sure that you didn’t make any outrageous claims in the first place. But the investor certainly has the right to follow up and reduce the risk they perceive in investing in you.
What will be investigated?
They are several other things they will investigate.
- All the financial information that you’ve provided, including a thorough investigation of your forecasts and claims about future profit.
- The performance of your business, to make sure you’re actually doing what you say you do.
- The existence and readiness of any working models or prototypes.
- The possible reaction of your competition to the investment being made. If the competition is a huge global corporation that might react unfavourably to added competition, then a strategy has to be designed to offset this.
- Who your suppliers are and if they supply you with product or services that are essential.
- Whether the suppliers are stable and reliable. If you rely on one particular product from a supplier, and that supplier goes bankrupt, your business may be dangerously exposed.
- Key customers, to ensure they will still do business with your business when the shareholding is changed. A key client might have a conflict of interest with the investor buying into your company and, therefore, decide to take their business elsewhere.
- Whether key employees and management are happy about the buy-in and will stay. The investor will not want to upset employees. Existing management must also be happy with a possible shift in power away from the owner–operator towards a more formal board management structure.
- Any tax issues or hidden financial surprises for the investor, such as pending lawsuits or undisclosed liabilities.
- What control functions exist, such as internal auditing mechanisms? How do you account for cash and product movements? Where are the potential employee theft problems?
- That the accounting record system is robust and accurate. Do you provide daily, weekly, monthly or bi-monthly reporting to management? How timely is this information, and how relevant? Are you working with good information or bad?
Why are these steps necessary?
The reason investors need to conduct such an extensive investigation into your business is that it’s not possible to cover everything vital in a set of financial statements. As you know, a study of your profit and loss statement and the balance sheet doesn’t reveal all that’s really happening in your business. This is why you must prepare additional information to any potential investor.
The investor’s due diligence team will know what they’re doing. Typically, they specialise in certain industries, so be careful – they may know more than you about some aspects of your own business! And if they don’t, then they will have access to their own group of experts. This includes lawyers who will follow up on any of your patent or trademark claims, to make sure you do own the intellectual property, or that your lawyer has done a proper job.
The importance of legal protection
One of the most important areas an investor will look at is all the legal protection you have in place. They will want to ensure that all the patents, trademarks, and intellectual property you claim are in fact unencumbered by disputes or challenges and are really yours to sell (if this is your business model).
Often, potential buyers will be in the same industry. They may even be your competitors! So you should give some thought to making sure you don’t tell them all your secrets, unless they appear pretty keen to actually invest in your business. It would be a good idea to talk to a lawyer about this and get potential buyers to sign confidentiality and non-disclosure agreements.
- This information is provided by New Zealand Trade and Enterprise
