Keiretsu Forum
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Keiretsu Forum Due Diligence
Advice from a Keiretsu Forum Member and Fellow Entrepreneur
By Ralph Shaffer rdshaffer@softserver.net,
Keiretsu Forum Northern California Member
The Keiretsu Forum is more than a fund raising venue. Members generously provide sage advice to each other and entrepreneurs alike. The collective knowledge base and advantage of ‘swarm intelligence’, is a prime motivator for experienced angel investors to band together. Conversely, the opportunity to stand before the assembly attracts legions of entrepreneurs each year.
Successful presenters have survived a truly Darwinian process. Following their 20 minutes on stage, each receives a ‘gold sheet’ containing the names of interested members. From this moment, the challenge facing the entrepreneur is to satisfy the requirements of a team of inquisitive angels bent on fully understanding the venture, and assessing the risks and rewards of investing.
The ‘Due Diligence’ process can be laborious and lengthy, but when properly performed, the entrepreneur is rewarded with maximum investment from confident, informed angels.
Careful preparation can quicken the pace and prevent common faux pas that can cast doubt upon the company and the investment opportunity.
Last year, a dedicated team of Forum members created a comprehensive ‘Due Diligence Checklist’ that guides the process. This document is an invaluable and unique tool that provides both the entrepreneur and investors with a systematic means of thoroughly evaluating the target company, its assets, business, operations and key personnel.
Without doubt, every CEO, CFO and COO will ultimately praise this document as instrumental in preparing the executive team for successful fund raising. Indeed, the checklist will motivate and enable a review of corporate record-keeping, preparing responsible executives to participate, and focuses attention on what matters to investors: company business plan, GAAP financial reports, intellectual property, and much more.
Every company has one or more problems, usually an incomplete set of resolutions or meeting minutes, but may include vital corporate documents. In most cases, a call to legal counsel will yield copies or a log of their records quickly. If not already in place, a document control system must be established. This housekeeping will pay dividends over the course of the Due Diligence process.
Successful serial entrepreneurs eventually come to know a great deal about the art of fund raising. Many will have been on both sides of the investment process. The best are adept at running a business in parallel with satisfying investor requirements. Nonetheless, consider assigning the role of ‘investor liaison’ to another experienced executive, such as the CFO, to assure rapid, quality response to investor enquires and avoid delaying the completion of Due Diligence. The participation of the management team remains vital, but day-to-day availability of the CEO or other executives can be a problem.
Emails and conference calls are common means of communicating with investors. Documents attached to gold sheet broadcasts or one-on-one replies are very efficient. However, building a trust-based relationship with angel investors takes more than exercising digital resources. Gathering investors and key executives together will create bonds and build confidence for both parties. This does not require expensive or lengthy events; a focused presentation and coffee around a conference table, with ample one-to-one ‘networking’ opportunities, can be equally effective.
Fledgling companies often have difficulty in assessing and justifying their valuation. Unrealistic valuations are anathema to investors, yet every entrepreneur is motivated to minimize the percentage of ownership sold by maximizing share price. Frankly, only sensible, logical, and methodical valuations survive scrutiny these days. Pitching fantasy valuations will turn-off experienced angels, especially in the current buyer’s market.
There are many resources available that can help establish a rational company valuation. Web sites offering advice and formulae abound. ‘Management Models Financial Methods & Strategy’ is highly recommended. For true startups without a revenue history, but possessing a realistic 5-year sales and expense forecast that provides sufficient detail on net income and cash flow requirements, methods that utilize DCFA (discounted cash flow analysis) may generate a practical and defensible valuation.
Perhaps the most difficult task is negotiating the term sheet. This document may become quite complex, but must establish share type, price, and incentives, plus any conditions and covenants sought by investors or the company. Consider beforehand such issues as warrants, providing a board seat, and the need for and impact of future funding rounds. First, caucus with the Board and corporate counsel, then listen to the investors, prior to making any offer.
Normally, investors seek preferred shares, which are highly flexible compared to common. The only given is that holders have preference in the event of company dissolution, but this is seldom the sole advantage. It is best to gage the needs of investors first, and then consult legal counsel, to craft a balanced offering.
Warrants can also make or break a deal. These ‘options’ must be negotiated carefully, but are the best way to provide investors with dilution protection AND sweeten their eventual ROI without immediate impact on ownership and control. It is unlikely that the final deal will lack warrants, particularly if additional fund raising rounds loom in the future.
The bottom line: prepare to succeed.
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