The word crisis is comprised of two characters when written in Chinese, representing danger and opportunity, respectively.
Of late, we have seen a crisis unfolding across the global economic landscape with COVID-19. Undeniably, a crisis presents opportunities.
Between consumer retail businesses reimagining global supply chains and technology startups re-assessing business growth avenues, the conventional modes of work have been put through the shredder as we witness the emergence of a new normal.
As any investor will corroborate, due diligence is a critical component of an investment process. All PE/VC firms, family offices or institutional ones go through elaborate due diligence (DD) processes before investing in a fund or company.
DD has multiple legs- commercial, financial, legal, HR and more. Pre-COVID-19, the process involved exhaustive on-premises and in-person engagements, which would go on for weeks, if not months. Why? The outcomes from the DD stage can make or break a deal and differentiate between investors making or losing money.
The new approach, the virtual due diligence
As the world continues to digitise and innovate, DD remains stuck in a time warp of inefficiency. For many organisations, diligence still means a giant excel file containing a plethora of documents and checklists that are manually compiled and emailed back and forth several times among various stakeholders, including, but not limited to, investors, lawyers, bankers.
Online data rooms were being used in the recent past, especially when multiple investors were evaluating a deal. But still it there was an absence of real-time online collaboration.
The good news is that technology is bringing about a revolution. Following improvements in data management, connectivity, better record keeping, and video calls, many forward-looking investors and fund managers are seeing an opportunity to revitalise investment due diligence processes and infuse technology to weed out the inefficiencies.
A study by Omers Ventures of 150 VCs across the US, Canada, UK, and Europe shows that just 4% of VCs are opposed to remote deals.
Among 96% of VCs open to it, 42% are willing to alter processes to enable this. Interestingly, 40% of the VCs surveyed said they had already done a fully remote deal.
While technology advancement is gradually altering the traditional diligence process, the pandemic brought about a forced change.
With country-wide lockdown and social distancing, it became difficult for investors to do in-person diligence.
Investors have figured out ways to successfully diligence and invest in companies in an online world. As they say, innovation is the child of adversity.
Some key Operational and Strategic Shifts for Remote Due Diligence
In remote diligence, the genesis or the end goal of diligence does not change. The only change is in the approach to collecting evidence.
1. Observe teams/interactions during video calls
The manner in which team members interact with each other, the level of control exhibited by the CEO, whether teams have clear areas of responsibility, and whether the CEO delegates questions to them
2. Change the format, tone and tenor of video calls
Hold a series of one-on-one calls with each of the founders, rapid-fire Q&A to get insights into how the founders perform under pressure
3. 3x the number of calls
Although in-person meetings are vital, increasing the frequency of virtual meetings by up to 3x could bridge the gap to a significant extent
1. Become a customer
Use the product, look out for bugs, report them as a customer, and evaluate the user experience. You could pretend to be a customer and reach out to the company with queries
2. Take a data-heavy approach
Get direct access to the company's database to analyze basic metrics like acquisition cost, retention rate, lifetime value, average revenue per user.
3. Listen to customers' opinions
Identify the top customers and schedule calls with them to learn more about their experiences.
Market and Competition
1. Triangulate information with multiple sources
Investors can get a lot of information by tapping into the other investors and the expert network.
2. Competitor calls
The best way to check about a company is from the competition. Conduct a thorough competitor benchmarking, organise calls with other players in the sector to understand unique selling points and the overall direction of the industry.
Business model and financials
1. Capacity utilisation
Review team utilisation to assess any redundancies focus on the team's ability to sustain without any fundraise or post your fundraising
2. Digital presence
Draw insights on business strategy by carefully analysing social media posts to assess whether the company is adapting to new technologies, embracing the digital world, and has an online presence.
3. Data-heavy approach
Proof of the pudding lies in historical data, putting greater emphasis on unit economics, gross margins, CAC, burn rates, breakeven and scenario analysis.
Here are a few tips on how enterprises can ensure a seamless remote diligence process and increase the likelihood of a successful outcome.
Yes, the pandemic has accelerated a virtual environment for investors, as it has in many industry sectors.
However, it is worth noting that the phenomenon of the remote and distributed workforce was emerging long before the pandemic arrived.
The pandemic and the challenge that it imposes on due diligence should therefore not be an excuse to let the baton slip. It should be the catalyst that enhances scrutiny by utilizing technology to further augment existing processes.
(Ratna Mehta is Executive Vice President, Wadhwani Catalyst Fund at Wadhwani Foundation. Sanchit Kejriwal is Fellow, Wadhwani Catalyst Fund, Wadhwani Foundation.)
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