No Two Due Diligence Processes Are Alike
There are no cookie cutter due diligence processes. Every company is in a different stage, with different historical and forecast financials. Every client has different requirements and expectations. That’s why flexibility is one of the most important attributes you should search for in a due diligence, valuation, or financial forecasting provider.
In previous blog posts, I covered the importance of genuine feedback to startup founders (here) and the need for simplicity in tech startups' financial modeling (here). In this post, I want to touch another critical element of the tech investing world - the due diligence process.
Almost every week, I talk to clients who need due diligence on a target company. Whether the client is a private equity fund, an angel investor or an SMB manager, I often get the same query: how many hours will it take to perform the DD?
In the next step, I try to gather as many details as I can about the target company, deal complexity, deal status and more to understand the magnitude of the project. Many of these details are confidential, and the client is (rightfully) willing to provide all this data only after we sign a contract and an NDA. Now, we are in a chicken and egg situation where the client can't give any useful data for me to assess the project's scope and I can't evaluate the project's scope without understating all (or most) of the details.
"However, not only the clients' expectations are different between deals, but also the status, profile and business of the target company in many cases dictate a different type of due diligence."
In this point, the conversation is usually evolves differently depending on the type of client.
Investment fund manager
This client could be a VC, private equity or a hedge fund. They are usually sophisticated investors, and this is not their first rodeo. The fund managers understand the complexity of assessing the project's scope with limited information, and we usually agree on a preliminary stage of exploration that includes signing the contract and NDA, initial review of the documents, defining the scope and setting milestones.
These clients, usually have larger budgets, know precisely what they want, how they want it and when they need it.
Small-medium business manager
This client owns, works or represents a small-medium business who is looking to acquire or invest in another SMB. These clients have less experience in M&A, and therefore they are less sophisticated investors than the fund managers and have less experience in these activities.
These two types of clients might look for the same thing on the surface, but they could not be more different.
While the investment manager that contacted me is looking for a high-quality in-depth and comprehensive financial due diligence on a potential deal, the SMB manager doesn't know precisely what he's looking for.
While the investment manager expects to receive a financial due diligence report analyzing the target company's financials, business, valuation and other financial aspects of the deal - the SMB manager expects to receive a financial, legal, technical, business and strategy analysis.
However, not only the clients' expectations are different between deals, but also the status, profile and business of the target company in many cases dictate a different type of due diligence.
An early stage startup that is in the development stage, bootstrapping its activity, with no clients, no historical financials will require a different due diligence work than a more mature startup that already raised funds from multiple investors, has clients and revenue and a few years of historical financials.
The due diligence for these two companies will vary in depth, length, and focus. While in the early-stage company the entire focus will be on the potential of the technology, product and the company's ability to scale - in the mature company the focus will split between analyzing the historical financials which include previous sales, transactions, performance, business decisions, etc. and the potential of the technology, product and ability to scale in light of the company's historical performance, market acceptance and feasibility of the company's financial plan and roadmap.
Not all Due Diligence Processes Are Created Equal.
This blog post was written by Lior Ronen, Founder and CEO of Finro. The information provided in this webpage is for informational purposes only. Neither Finro Limited ("Finro") nor any of its affiliates makes any representation or warranty or guarantee as to the completeness, accuracy, timeliness or suitability of any information contained within any part of this webpage not that they are free from error.