Taming the Dragon- Secrets of Due Diligence (Nelson Gray)


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Slides from Connect Estonia seminar CONNECT WITH THE SMART MONEY, on August 29, 2006.

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Taming the Dragon- Secrets of Due Diligence (Nelson Gray)

  1. 1. Due Diligence Nelson Gray nelson@nelsongray.com
  2. 2. !" # # $ # $ % # &# # &$ ( # ) * + , 2
  3. 3. Reality“I should have done a lot more duediligence because a lot came out of thewoodwork in the balance sheet in avery different light and I would neverhave invested.If I had to do it again, I would have dugdeeper and not been in such a rush toput the money in” 3
  4. 4. Post Investment Depression • Wish I had: – Done more due diligence – 36% – Had more contractual control – 13% – Invested more – 8% – Not invested – 8% – Recruited more people – 6% – Monitored more – 3% 4
  5. 5. Perception of the Deal Process Finding Deal flow Initial Screening Due Diligence Valuation Negotiation Legals Monitoring Mentoring Exit 5
  6. 6. Due DiligenceWhy do it ? The Investor -• To get to know the management.• Evaluate the opportunity against your investment criteria / strategy.• To reduce your risk – find the “lies”.• Identify areas for focus – danger areas.• To make go/no-go decisions. 6
  7. 7. Who does the Due Diligence?• Lawyers?• Accountants?• Consultants?• The lead Investor?• Yourself? 7
  8. 8. Scope of DiligenceMarket Technology IPR Sales & Mkting•Size •Technical Risks •Patents •Value Proposition•Trends •Competing •Trademarks •Business Model•Competition Technologies •Know-How •Sales Forecasts•Oppts & Threats •Product Mfr •Design Rights •Routes to MarketPeople Operations Finance Legal•Mgt Team •Product Delivery •Balance Sheet •Staff•Key Staff •Customer Support •Cash Flow •Premises•Roles & •Systems & Controls •P&L •Suppliers Responsibilities •Health, Safety, •Mgmt Info & •Customers Environmental Internal Controls 8
  9. 9. Due Diligence – When?• Before you get the Plan. – General Market Knowledge. – The Source of the Deal.• When you read the plan. – Personal Fit. – Common Sense.• When you meet the Management – Do they have “it”. 9
  10. 10. Due Diligence – When?• During Negotiations – What are Management like under stress? – Still a consistent story? – Are they listening?• Before you Sign the Paper – Have a reality check • Business Still on Track? • Deal still Sensible? 10
  11. 11. Elements of Due Diligence• Screening Due Diligence.• Management Due Diligence.• Due Diligence on Intangibles.• Business Opportunity Due Diligence.• Financial Due Diligence.• Legal Due Diligence. 11
  12. 12. Screening Due Diligence• Quality of source, the plan, etc (Use of application forms?) 12
  13. 13. Angel Decision Making• Initial Screening – Personal Fit & Junk Filter (73%)• Detailed investigation – Due Diligence (22%)• Negotiation and Contracting – Only 5% get this far! 13
  14. 14. Due Diligence on Intangibles• Not “Intellectual Property” – but - – Focus, momentum, buzz, your gut feeling. – Will this be “Fun”? – Can you add value? 14
  15. 15. Management Due Diligence• Managements view of investors.• Their motivation.• Are they really Entrepreneurs?• Do they have a CEO?• Why will they be a successful team?• Can you add anything? 15
  16. 16. Portfolio Fit?• What will they be like after the deal?• How will they behave in the hard times? 16
  17. 17. Business Opportunity Due Diligence• Customers.• Business model / scalability / market channels.• Can it make required rate of return / IRR?• Exit. 17
  18. 18. Remember the Basics• Technology is rarely the reason for failure.• Sales and marketing areas of weakness – Many companies lack “polish”.• The USA seen as a key market – but most Non US companies struggle with this. 18
  19. 19. Financial Due Diligence• Historical, Forecast & Present.• Burn rate.• How cash to be used – development or past failings?• What did the last business plan promise?• Is the next funding addressed in the plan? 19
  20. 20. Legal Due Diligence• History• Tax A link between Due• Structures (EIS) Diligence and the• Litigation Legal process –• IPR• Contracts •Warranties• Staff •Indemnities 20
  21. 21. At the end of the dayWhatever the Due Diligence Results Suggest: If it doesn’t feel right, it isn’t right. 21
  22. 22. Investor ReadyReverse Due Diligence 22
  23. 23. Gabriel or LuciferThe Companies Due Diligence.• Basic Chemistry » Do you like them? » A balanced Board - match long term needs of Co » Control demands reasonable » Distribution requirements reasonable• Get References• Watch out for tyre kickers• Do they have the cash? – Follow on• Work with them before committing. 23
  24. 24. Due Diligence Conclusions• It’s an ongoing and continuous process.• It’s an evaluation against personal criteria.• Results will be evaluated in a personal manner.• It should take a reasonable amount of time.• Have a reality check before moving on.• It should be a two way process.• It provides opportunities for entrepreneurs.24