Sunday 20 October 2019

Make sure you make the most out of due diligence by investors

The imitation game: Scanning documents you’ll get from the Revenue Commissioners will make it much easier to access them later when you need to review something
The imitation game: Scanning documents you’ll get from the Revenue Commissioners will make it much easier to access them later when you need to review something

Richard Rodger

As you work through a funding process, you'll eventually hear the words 'due diligence'.

Due diligence is the work that an investor does to verify that your company actually can work, and that everything you've said makes sense. Nobody really invests just on the basis of a pitch. When there's real money involved, you need evidence.

The process of going through due diligence is one that many founders dread. But as with everything that you can't avoid in the life cycle of a startup, the key is to find some way to reuse the work to improve the company.

It's a basic startup hustle to get the most out of the work that you are doing.

If you're a founder of a company, then you're probably also a director of that company.

That means you have specific duties to ensure that the company is well-run.

In practice this means keeping good records. Company records are the first thing that will come up for review in due diligence. You need to have all the basics in place. Let's review these and see how you can plan ahead, or fix things, as the case may be. The best time to solve these issues is in the early days, when you're not quite so busy keeping clients and investors happy.

A company needs to keep its accounts up to date. You won't get far handing over a shoebox of receipts to your investors. For a startup, your best option is something like xero.com - keep it all online. It's important that you're able to import your bank statements electronically as that saves you a huge amount of time.

It's best to take the advice of your accountant on this one.

The big advantage of using an accounting system is that you can generate reports to understand your business. For a startup, that's mostly about understanding your burn - how much money you're spending to build the business.

In particular, you should be able to generate cash flow reports. These can then be used directly to build your cash flow projections (I covered building a business model in an article two months ago).

It's good to model your business on actual numbers so that you can be credible for due diligence.

Unfortunately, you will still have to deal with paper records.

You'll get bank statements and the occasional cheque. You'll have hotel and taxi receipts from travel expenses.

You'll get notices from the Revenue Commissioners. As a rule, you should institute a process of scanning all these paper documents.

Yes, you'll need to file them physically, but if you also scan them first, you'll find it much easier to access them later when you need to review something.

If you're using an online accounting system, you can also upload the scans so that they are directly associated with the correct transactions. This is a big win.

You'll also need to make sure your intellectual property is secure if you want to pass due diligence.

There's no point having trademarks, parents and copyrights in your own name. These need to be transferred to the business. You'll need a solicitor to get that right. If you've done some development work, say software prototypes, before formally starting the business, you need to make sure that the business ends up owning everything.

Your investors need to know that the intellectual assets of the company are actually owned by the company.

Of particular importance in this regard are employee and consultancy contracts. If you're building a software startup this is really important to get right.

The contracts need to include a clause that assigns ownership of intellectual property to the company.

If you don't do this right, you can easily end up paying for something that you don't officially own.

It's never a good idea to get software development work done on a casual basis. When the time comes for funding, investors will look for all of the contracts with staff and consultants to ensure this is the case. The best way to ensure that you can trace the provenance of your software is to use an online service such as github.com from day one. This shows every change in every line of code, and who made the change. You can prove very easily that all of your code-base has been built under appropriate intellectual property controls.

There's a great deal more to passing due diligence, such as validating your market and allowing investors to talk to your early clients. It's a subject I'll return to. However, just getting a good system in place for your accounts and getting your employment contracts right, will ease a lot of pain when you close your first funding round.

It's impossible for an investor to check everything. A lot rests on your word as a founder or founding team. You will be asked to warrant that you have given an accurate description of the business and the market, and the activities so far.

These clauses can be pretty intimidating. Again this is where you need your solicitor to go over things for you.

The best policy is also the easiest - be open and direct about the state of the business. Be transparent with your records and systems. In our case, we've been happy to share as much as is needed. Things like customer discovery interview notes contain much that is positive, but can also contain negative points. You need to share them as is.

In the case of voxgig, we're lucky to have started from a position of transparency as a basic company value. You're getting a week-by-week account of our triumphs and defeats. And you're getting a direct insight into our thinking and how it has evolved over time. As everything has been published in public, our investors also get the same insights into what they are buying. For those that have decided to come along for the journey, this makes them more valuable to use, because they understand the challenges and open questions, and can help us build a better company.

Marketing update: the Eventprofs newsletter, which is our community newsletter for event organizers is at 328 subscribers and an open rate of 37pc. The subscriber count is too low to attach much significance to the open rate just yet. Speakers Newsletter, our original newsletter for technology conference speakers, is at 5,275 subscribers, and an open rate of 15pc - so it's all fine and on track there. The podcast is the poor relation, with 19 downloads in the last week - staff holidays and travel mean we're not yet executing our marketing plan for the podcast - such are the frustrations of startup life.

As noted last week, the key marketing activity at the moment is putting in place a repeatable process, using what we've learnt with the speakers newsletter to promote this content (which ultimately drives user registrations), and build trust in the company.

Richard Rodger is the founder of Voxgig. He is a former co-founder of Nearform, a technology consultancy firm based in Waterford.

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