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Tag: due diligence

Join the angels

If you’ve ever thought of becoming an angel investor, the new Be an Angel web site, launched today, is hosted by the British Business Angels Association, and has been designed to provide you with the information and resources you will need before making your first investment.

The launch of the Be  an Angel web-site coincides with the launch of Lord Young’s Enterprise report “Make Business Your Business” being launched today and a new £82m loan scheme for young people seeking to set up a new company.

It’s aimed at raising awareness  and encouraging individuals to become Business Angels,  giving detailed information and advice about the overall angel investing process and identifying the risks and rewards. The site also includes new downloadable fact sheets  on due diligence as well a  newly revised legal precedent documents and a new revised guidebook on technical and regulatory issues related to Angel investing. It also includes quotes from angels (including yours truly)  about why they became angel investors and encouraging others, as well as entrepreneurs that have received angel investment.

I’m welcoming of this online initiative, together with the enthusiasm that the government is showing for upping the rate of formation of new businesses.  In the end though, it’s up to us as individuals to decide whether we want to back these businesses with our hard-earned cash.

Advice for Entrepreneurs: Part Eight – Due Diligence Process

I’ve been asked to join the panel at a London Business Angels investor club night this week.  The event will focus on the topic of due diligence.  To get the juices flowing, I’ll focus here on some key aspects:

Staged due diligence is vital

The amount of time and effort put into gathering information needs to be staged to be fair to you and to the prospective investee.  In stage 1 we simply evaluate the business plan, presentation or other initial interaction.  In stage 2 we ask more questions but take the answers at face value.  At stage 3 we seek to reach a detailed conclusion as to whether we would like to invest in the company.  This is the main stage at which we take the technology, product/service and market apart and seek to understand them thoroughly.  Finally at stage 4, we seek to ensure that the legal and financial terms are fully acceptable.  Our experience is that the decision to pass from one stage to the next should be taken seriously and with regard to the time and implied commitment involved.

Decide how much to do before agreeing terms

We’ve varied in our approach to the amount of due diligence we do before agreeing investment terms. On one hand a greater degree of upfront research will indicate areas for further discussion and investigation.  It will also uncover issues that change our views on valuation or our interest in investing.  On the other hand, an early term sheet shows commitment and gains exclusivity.

The company seeking investment should provide the information

When I started investing, I would spend a lot of time undertaking my own research into the market prospects for potential investments.  Whilst we still do this on occasion, it’s far more valuable to understand what the company knows.  Our approach now is to provide the company with a set of headings for the main due diligence, and expect them to populate a dropbox folder with their information.  This has the twin advantages of helping us to understand the depth of the company’s own understanding and providing the basis for the warranty disclosure letter at the end of the process.

Talk to customers

An invaluable part of the diligence process is a series of calls to current and prospective customers.  Are they happy with their interactions with the company?  Does the product perform? Do their projected orders correspond with the company’s sales projections?  A few structured calls undertaken by a market research professional can be illuminating.

Don’t overdo it

It’s possible to overanalyse a prospective investment.  This can result in wasted time and thus deflate the return on investment.  With early stage technology businesses, especially those that are pre-revenue, some questions cannot be rigorously answered and the decision will come down to your personal judgement.  I always ask myself the questions “will this piece of research contribute directly to my investment decision” and “do I think that the management team will find the answers post investment”.

Undertaking a structured due diligence process is a super way of learning about the business and its management team.  Executed properly it leaves me with the confidence to entrust the company with my investment, or to walk away from the deal safe in the knowledge that ‘this one’s not for me’.

Is your product really ready for the market?

I’ve been reflecting on the state of product maturity at the time entrepreneurs seek external investment. I tend to use Technology Readiness Level (TRL) as a starting point for discussion with entrepreneurs.

It’s relatively easy to distinguish between ‘concepts’ (TRL2-4) and ‘development projects’ (TRL4-6) which may be suitable for pre-seed, seed or early stage investment, but it’s the stages nearer to market (TRL7-8) that have been exercising me recently. We’ve been presented with several opportunities recently, each having made first sales, and claims that investment will accelerate the company up the ‘J’-curve to substantial sales revenue.

I suggest that four questions should be posed:

  1. Are the installed systems the final production version?  If not, can they be upgraded to this standard to provide a solid customer reference base?
  2. Can the first 2 years of sales post investment be fulfilled with exactly today’s products?  If not, what proportion of sales over this period is contingent on further R&D, and is this provided for in the business plan?
  3. What ‘cost-down’ programme is envisaged to reduce manufacturing cost as volume increases? Is this already specified, or a vague statement?
  4. What proportion of the funds will be applied to sales & marketing versus R&D?

One opportunity seemed less attractive when we realised that the experience of 20 installations had shown that a complete product redesign was required. So the next year would be spent in development before sales could recommence. The company had reached what it saw as the finish post, but to me felt like a new starting line.

Another entrepreneur told us his product was ready for manufacture of a batch of pre-production prototypes. Further discussion revealed that at least two further design iterations were required.

A third company has placed 3 ‘beta’ units, now has 10 ‘v1’ units sold, and has demonstrated that it can sell the next 2 years’ forecast based on the current platform.

So are these companies at TRL 7, 8 or 9?  Do they understand TRL or are they kidding themselves?

Advice for Entrepreneurs: Part Three – Intellectual Property

Investors and entrepreneurs alike face real problems in the role of Intellectual Property (IP) in technology businesses. IP represents a defence, a barrier to entry and source of sustainable competitive advantage if competitors find it hard to copy or work around your IP. But the cost of worldwide filing for a single patent is in the high tens of thousands of pounds. This is hardly money that entrepreneurs have access to in most circumstances.

Very few companies come to us with a portfolio of granted worldwide patents at the stage we meet them. So what’s the acceptable level of preparation required by people like us?

Patents filed without the assistance of a patent lawyer worry us, as it’s easy to make mistakes that narrow or invalidate your claims. We can help you to find a decent, commercially focused patent lawyer, or even better a commercial IP consultancy that can undertake the following:

  • Independent analysis of your IP. This should be presented to us, together with your responses. This should provide some confidence in your approach to date and in your ‘freedom to operate’ without infringing IP held by others.
  • Strategy for developing a strong IP position. This should address (a) filing strategy (scope, territories and likely costs for your business plan), (b) landscape and freedom to operate and (c) likely work-around strategies that could be deployed by competitors.

We tend to take a simple approach:

  • Does the IP provide a fundamental barrier to competitors? This is usually evidenced by simple, fundamental and broad claims that have passed examination and preferably reached PCT stage.
  • Alternatively, does the IP only protect the particular means of producing your product or service? In this case, competitors will use alternative approaches to work around your IP. You will need to demonstrate reasons why you will dominate the market before they catch up.

If you can present this material to us at the outset of stage 2 evaluation, you’ll be giving us confidence in the validity of your approach and in the defensibility of your technology.

I know IP is troublesome and expensive. But it’s essential nowadays, and it shows your professionalism if you take it seriously at an early stage. There’s also no reason to go overboard – you need to do enough to convince your investors, not more.

Advice for Entrepreneurs: Part Two – Due Diligence Material

This is the second in a series of blog entries intended to give advice to entrepreneurs who approach Qi3 Accelerator.

Think about it from my perspective.  It’s much easier to invest in a proposition if you have already thought through all of the questions that people will ask you, and prepare concise written material to release to potential investors who show serious interest.  Your preparation will thus look professional, and save me time scratching my head.

When I invested in On-Sun, one of the Anglo Scientific stable of companies, I was impressed that the entire due diligence pack was available for download from a secure web site.  This made the investment process so much easier, and gave the immediate impression of competence and preparedness.

The obvious checklist of due diligence information includes:

  • Corporate structure, shareholdings, articles of association
  • Past financial accounts and up to date management accounts
  • Service Agreements with key staff
  • Evidence of contracts and grants in place
  • Schedule of Intellectual Property with status
  • External market assessment
  • External technical assessment
  • External IP assessment
  • Appendices to the Business Plan, showing how assertions were arrived at

In the case of On-Sun, the due diligence pack also included the directors’ responses to the external assessments, so I was able to feel a conversation going on and understand more.

In contrast, it’s amazing how some entrepreneurs seem to expect the potential investor to dig out all of this information themselves, and not get bored or give up in the process.  Due diligence should be a matter of reducing risk and confirming one’s interest in a business.

This may seem daunting from the entrepreneur’s perspective.  But I can assure you that a well prepared due diligence pack speeds up the evaluation process and leaves a good impression.

 

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