Managing expectations is difficult. We make an assessment on information available at the time and it’s easy to succumb to overconfidence bias or say what’s going to get the best response – this is a one-way trip to Overpromise Land from where, try as you might, there’s no escape. The first Offer Letter I issued as an investor came with the inexperienced and overly confident suggestion that the due diligence (“DD”) process was going to be so lite-touch you won’t even notice us… Regrettably, I spent the next two months during DD having to explain to the management team why we were distracting them from delivering on their numbers and wasting valuable time and resource on an unnecessary process.
A painful lesson learned for me – don’t overpromise, be realistic and focus the process on key risks/opportunities.
The DD process is a chance for management teams to test their business plan, strengthen the platform for growth and tidy up those inevitable areas of ‘house-keeping’ in advance of an ultimate exit. While it will distract you from running the business, it is a good opportunity to take stock before setting off at pace on the next stage of the journey with an investment partner in support.
Here are five tips for getting the most out of the DD process:
1. Discuss the key areas of focus and level of comfort that your investor is seeking.
The statement “here’s our standard DD scope” should be a warning sign, and probably follows a “here’s our standard form documents” and precedes a “here’s our standard form board report”.
DD should focus on the key areas of risk and opportunity, be proportionate to the scale of the business and weight its assessment by the importance to the business plan. A rigid approach may suggest a lack of understanding of the business or opportunity by the investor. Be sure to discuss with your investor what they want to validate and what evidence is going to provide that validation.
2. Be sure that your investor has done the right level of work prior to issuing a Term Sheet, DD should be confirmatory, not exploratory.
Different investors issue Term Sheets at different stages of a process. Beware of those looking to get into ‘exclusivity’ before they have done the work to back it up. Test the credibility of a Term Sheet with a discussion around what work the investor has done (if it’s not already apparent from time spent with you and your team).
DD should be looking to help validate the key investment thesis, not create one.
3. Feed into the DD scopes.
This is an opportunity to get some valuable insight from your customers and do the market research you’d otherwise not get round to doing. It can help you with questions about your pricing, sales process, and employee engagement strategy, for example. The output of the commercial work can often be repurposed for your sales and marketing collateral. We think about DD the same way we think about investments – what is the ROI?
Ian Stone, CEO of Vuealta says: “The go-to-market strategy and commercial review that we undertook as part of the YFM growth capital investment helped us to shape our sales & marketing strategy for the next 2-3 years and prioritise the development of a couple of key channels which we think are going to become the growth engine for Vuealta.”
4. DD reports should be full of value-add recommendations that feed into your plans and management information.
The recommendations made in DD reports should be aimed at maximising the future value of your business. By acting on these early, you’ll strengthen the foundations of your business. Incorporating the best recommendations in your management information, KPIs or strategy day agenda will ensure you’re frequently looking at your business through the eyes of the ultimate acquiror.
Simon Goodenough, CEO of DSP-Explorer says: “The recent investment from YFM and due diligence process helped us get a good view on the acquiror landscape and gave us the headspace to think about additional KPIs to track as our business moves to the next stage of growth.”
5. Lean on your advisor and keep perspective on the process.
The DD process will require significant involvement from the senior management team. However, this should be limited to strategic areas of discussion and review. Process management, information flows and first level responses should be dealt with by your advisors as much as possible. The last thing you want in a pre-investment process is for the business to lose momentum, so make sure you have enough bandwidth and good advisors supporting you.
One of the most important parts of the process for us is getting to know the people and teams we’re backing. Getting out of the office together for dinner, mountain biking, surfing, crazy golf, etc, is a really important way of getting to know your investment partner and keeping perspective on the process – it’s another form of DD, and arguably the most important of all!