Due Diligence in Venture Capital | { Valuqo Capital }

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Quality due diligence work is how venture capital identifies good investments in the ocean of possibilities. This work is not as exciting as networking but, it's a vital part of closing a good ratio of high-value deals. 

Venture capital due diligence can be challenging, but if you follow the right way, it doesn't seem difficult. With an effective due diligence process, you get a better understanding of the market landscape and target start-ups before presenting a term sheet. 

What is Due Diligence?

it is a process of appraising a company's current state of affairs and its commercial potential. Due diligence in venture capital refers to the detailed understanding of the target company, its assets, liabilities, and management. 

This practice ensures that all risk is accounted for and understood so that there are no barriers in investing process and the target company has a good foundation.

Why Is It Important?

Unlike Private Equity which tends to invest in an established business, venture capital firms invest in start-ups. Start-ups are harder to access, especially early-stage start-ups companies as these companies have less substantial evidence to demonstrate their value.  

By gathering all the relevant information and thoroughly accessing and appraising this information, can a venture capital firm be assured that the return on investment would be high?

Which Areas Should Venture Capital Focus On in The Due Diligence Process?

Every venture capital firm has its own way of conducting due diligence and each prospective investment requires a unique approach. 

There are various categories of information that every venture capital firm take into account to collect insights: -

Financial: -

The company's finances are the most important information for the venture capital firm to assess the potential of start-ups investment. irrespective of a firm and target company, there's a huge list of financial statements and information to assemble. Some of the documents are

• Cash flow statement 
• Income statement
• Balance sheet
• Customer acquisition cost
• Materials contract
• Intellectual property
• Customer lifetime value 
• Leases
• Inventory 

Legal: -

The venture capital firm should look for the delusion that may indicate a mismatch between start-ups’ legal standing and what they have reported to the Venture Capital Firm. In this area, the venture capital firm has a certain level of control over the investment. Documents included in this area of due diligence: -

 

• Article of incorporation
• List of shareholders
• Bylaws and amendments
• Annual reports
• Compliance with state and federal laws
• Outstanding liability

Market: -

This area includes the product that the start-ups sell. The venture capital firm determines the potential for the growth of the company in the market. The information included: -

 

• Market size
• Market growth trends 
• Competitive Landscape 
• Sales volume 
• Product pricing 

Product: -

Financial, legal, and market may look promising but if a start-up isn't selling the right product to the right market, they are not likely to succeed

Key metrics that venture capital looks for: -

 

• How is the product built?
• How the company will deliver value to the customer
• How is company’s product differentiated from the competitor's product?

Business Model: -

Before understanding how venture capital will make money, understand how the company is set up to deliver the product. The information includes: -

• The current business models 
• Customer perception about the value provided by the product
• Potential for recurring revenue
• Scalability of the business model

Founder Or Management Team: -

The venture capital team members along with investors spend time with the portfolio's company's founder, co-founder, and management. It's important to know about the key players in the deal process. The company's founding team is the indicator of the company's trajectory.

The founder or co-founder may be an important factor for the early stage or seed stage, or later stage, other management should also be considered. Tracking key changes in a leadership role can act as an indicator for Venture Capital Funding to follow up on the potential deal. 

 The information includes: -

• Relevant experience 
• Related professional credentials
• Track record with other countries they have founded 
• Exit strategy and IPO plans 

Process of Due Diligence: -

Stage 1- Screening Due Diligence

There are many investment opportunities in the market but not all of them are good for the firm. This stage helps in segregating the companies which do not fit the firm's ideal company profile before any deal proceedings. 

In this screening, venture capital firms measure what they know of the target company against the fund's investment criteria. If the company meet the criteria and VC firm team member can further look into the deal. 

Stage 2- Business Due Diligence

If the company passes stage 1, then the VC firms move to the next stage of business due diligence. In this stage, the venture capital firms look for the market, product, business model, founder, or management to evaluate the company's current progress. 

Stage -3 Legal Due Diligence

If the company passes the above two stages, venture capital firms move forward with a favourable investment decision. Venture Capital team members and a lawyer verify the company information and analyse the risks deeply. Talk to Valuqo Capital for ideal investment decisions.