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A look into the detail that investors will put you through as they do due diligence

A look into the detail that investors will put you through as they do due diligence

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10.5 due diligence.pptx 10.5 due diligence.pptx Presentation Transcript

  • This presentation is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this presentation are the sole responsibility of Rick Rasmussen and do not necessarily reflect the views of USAID or the United States Government. The Due Diligence Process We like the deal but we have just a few questions…
  • Intent of due diligence •  Finding all the reasons NOT to invest •  Investors need to sort through risk factors: –  Corporate Structure –  Encumbering Relationships –  Industry / Competitive issues –  IP and Product completeness –  Sales and Distribution channels, warranties, etc. –  Management team, board, investors –  Financials
  • Starting Due Diligence •  Company needs to know –  No commitment to invest at this stage –  Deal terms may change if there are issues •  Form a Due Diligence Team –  Develop a plan to uncover risks –  Make assignments, set a timeline –  List of deliverables •  Communicate plan to company •  Make them understand that they are responsible for everything •  Due diligence should be completed to each investors satisfaction •  An angel or VC firm - If you are not satisfied, you should not invest, even if others are planning to push forward
  • General Corporate •  1.1 Company Information –  1.1.1 Current Business Plan –  1.1.2 AIl PowerPoint Slides including pitch decks •  1.2 Organization Chart •  1.3 Capital Stock •  Most recent, detailed capitalization table including employee stock option pool (issued and remaining) and warrants. •  Evidence of securities filings and/or compliance for all issued shares and outstanding options. •  All prior funding round documents, including stock purchase agreements, shareholders agreements, side letters, etc. •  1.4 Articles of Incorporation, Bylaws and Minutes
  • General Corporate II •  1.5 Leases •  When you moved into your current premises. The deal (e.g. lease terms), and how long it will be suitable as you grow. What are your current plans for expansion and where? •  1.6 Mergers & Acquisitions •  Provide a schedule of businesses acquired by XYZ since inception. Indicate purchase price, date acquired and schedule of assets and liabilities acquired, or equity exchanged. •  1.7 Public Relations •  Brochures and Literature. All brochures, reports, studies or publications relating to or describing XYZ and its products or services, including sales and marketing literature. •  Press Clippings and Releases. Press clippings, articles and releases relating to XYZ and the industry for the past three years. •  Analyses and Reports. Analyses of XYZ or its industry prepared by investment bankers, engineers, management consultants, accountants or others, including marketing studies, credit reports, geological reports and other types of reports, financial or otherwise. •  1.8 Litigation •  A description of all litigation or threatened litigation current, concluded or settled since inception and all documentation (including litigation files, settlement agreements, decrees, orders and judgments) with respect thereto.
  • Industry Background •  2.1 Competitive Information (full disclosure) •  On each competitor, broadly construed to include your existing customers and their current methodology. Information such as size of company, location, revenues, features, niche focus, product offerings, public/private, venture backed, pricing, your competitive advantage, sales/distribution strategy, etc. •  Provide the estimated lead time for an existing competitor or future entrant. •  2.2 Provide Industry Demand •  List and flesh out the key demand factors in the market. •  A list of market-knowledgeable references who can speak to the emergence of the need for your product, how your company fits into the market, why you might succeed, who the competition is, etc.
  • Products and Services •  3.1 Products and Services –  Describe the product and/or service in detail –  Provide every corporate presentation that’s been given to date –  Discuss future products and when they might be released
  • Intellectual Property filings •  3.2 Patents, Trademarks and Other Intangible Assets (as applicable) •  Information with respect to all foreign and domestic patents, trademarks, trade names, service marks, copyrights and other intangible assets used in the business of XYZ and all agreements (including, without limitation, license agreements), documents or filings governing such use. •  3.2.1 Copies of all Patents and all documents relevant thereto, including but not limited to any and all offers by third parties to license similar technology, any and all internal reviews of prior art, any and all demands by third parties to cease use of any patent or allegations by third parties that they contest in any form XYZ's rights to the patented intellectual property. •  3.2.2 Copies of all Patent Applications and all documents relevant thereto, including but not limited to any and all responses in an form by the U.S. Patent and Trademark Office or any foreign government or regulatory body charged with registering and or examining patent applications. •  3.2.3 A report showing the status of the Patents, and of any inventions for which a patent application has not yet been filed. •  3.2.4 Copies of all licenses that have been granted by the Company to third parties which involve the Patents or other intellectual property rights.
  • Sales and Distribution •  4.1 Strategy Detailed sales and distribution strategy. Discuss different types of customers and the corresponding sales cycle time for each. •  4.2 Customers and Suppliers All current marketing and distributorship agreements or arrangements, sale or supply contracts and purchase contracts (including any government contracts), including requirement or service contracts of XYZ, including the following: –  4.2.1 Contracts or agreements with any international, national, regional or local representatives, distributors or resellers. –  4.2.2 Contracts or agreements with manufacturers. –  4.2.3 Service and manufacturing agreements and contracts. –  List and description of XYZ’s customer base including quotes outstanding, current backlog by account and the most palpable prospect list for the next twelve months. –  List and description of XYZ’s vendor base. –  Please provide a list of customer references who have purchased your product and/or service.
  • Sales and Distribution II 4.3 Joint Ventures or Partnerships –  Documents on all present or pending joint venture or partnership agreements and other such arrangements in with XYZ is a party or is otherwise involved. 4.4 Licenses and Royalties –  Documents on all license and royalty agreements. 4.5 Sales Contracts –  Standard form sales contracts, agreements or arrangements. 4.6 Supply Contracts –  Documents on all agreements with suppliers. 4.7 Nondisclosure Agreements –  Documents on all secrecy and nondisclosure agreements, including employee confidentiality agreements, relating to technical and other proprietary information.
  • Sales and Distribution III 4.8 Other Significant Contracts Documents on all significant contracts, agreements and arrangements, other than those already enumerated 4.9 Warranty Claims A description of any warranty claims made against XYZ and any action taken with respect to such claims. 4.10 Noncompetition Provisions Description of any provisions which purport to restrict XYZ's ability to compete, whether imposed by agreement, court order, oral understanding or otherwise.
  • Management and Board of Directors •  5.1 “Key” senior management •  Resumes of all key senior managers –  Any legal actions, arrests, prosecutions •  One paragraph job descriptions of your next four key hires. •  Discuss key man life insurance policies. –  What executives have key man life insurance? How much? –  Is it payable to the company or investors? •  5.2 Board Information •  Bios of the formal board •  Agreements with board of advisors •  View of the Board post-financing. •  5.3 Management References •  3-4 professional references for all key senior managers   •  Reference  check  everyone  at  least  3x  
  • Credit Agreements All agreements of XYZ (together with all amendments, documentation and correspondence) relating to the borrowing of money, including bank lines of credit, letters of credit, indentures, notes, term loan and revolving credit agreements and debt instruments. Recent evidence of compliance with lending agreements 6.2 Loans to, or Guarantees of Obligations of, Third Parties 6.3 Guarantees All guarantees by management, stockholders or others of debt of or performance 6.4 Security Agreements All currently effective security agreements (including a recent UCC search) covering assets such as mortgages, pledges, liens or security interests in significant personal property, such as receivables, inventory or equipment. All currently effective security or pledge agreements covering capital stock held beneficially or of record by any selling shareholder. No need for “audited” financials but pour through the books
  • Financial Statements •  7.1 Detailed Historical Financial Statements, since inception •  7.2 Projected balance sheets, income statements and cash flows. –  minimum of three years). –  The projections should include any major assumptions utilized to develop the projected financial data, including (as applicable): –  New product/service introductions. –  Market share data, general industry expectations. –  Expected reactions from competition •  Revenue growth rates and operating expenses. •  Salary and headcount figures to correspond with the projections. Please break- out by Sales, Engineering, Manufacturing and G&A employment. •  Revenue detail by product/channel (including any volume and pricing assumptions).
  • What are you going to do with this money? •  7.3 Use of proceeds schedule. •  Milestones. •  How much cash do you need and when? –  If you raise a round, they will likely require milestones and issue payments accordingly.
  • Exit Strategy 8.1 Liked Exit types Strategy 8.2 4-5 likely acquirers and why they would be compelled to buy you
  • Investment Due Diligence Once you’ve gathered all the data…. Is it a good investment? Strong potential for 10x return? •  Build Optimistic and pessimistic financial model •  Careful assessment of sales cycles, revenue plan, cost structure, profitability, balance sheet items •  Capital requirements through life of the investment •  Sensitivity analysis (e.g. delays in execution are very common) •  Sources and uses of funds •  Fundraising plan •  Exit valuation & comparable •  ROI analysis (cash flows by yr., years to exit, times capital returned) •  Very helpful to test above against what other similar startups did •  Look at sales ramps, capital needs, exit values for 5 best startups What valuation do you need to get a 10x return, assuming it performs as well as other leading startups in same space?
  • Legal Due Diligence •  Everything, Everything and Everything •  Articles of Incorporation, charter, bylaws, etc. •  Minutes and consents of the board of directors and shareholders •  All signed contracts •  Copies of any side letters, voting agreements, etc. •  Employment agreements •  Confidentiality and invention assignment agreements •  Litigation-related documents •  Patents and copyrights, and other intellectual property-related documents •  Filings and payments for tax, securities, customs, environmental ... •  List of property owned & leased •  Insurance
  • Representations and Warranties •  At the end of the process the company offers representations and warranties to the investors •  These concern the accuracy and sufficiency of the company’s disclosures as well as the existence of certain conditions –  Not everything is perfect –  Disclose and document issues that investors are willing to contend with •  These become part of the Stock Purchase Agreement
  • Due Diligence - Experts •  Consider using due diligence experts •  Sources •  Specialized consultants, industry analysts, technical experts •  University professors •  CTO's at non-competitive companies •  Use entire SHA members network to find the right expert •  Experts often need to be paid. Interested investors need to decide how to create a pool for payment. •  Use lawyers to review key docs •  "A penny of prevention is worth a pound of cure”
  • Investor End Goals •  Going  through  the  en8re  litany  of  what  could  trip  up  the   company   •  Iden8fying  areas  of  highest  risk   •  Trying  to  make  the  decision  of  risk  vs.  reward   •  If  possible,  make  the  investment   •  They’re  looking  to  stay  ac8vely  involved  and  de-­‐risk  the   company  as  it  grows  to  the  next  stage