Tag Archives: Due Diligence Process

Introduction

Fundraising is a tool to achieve a collaborative dream. It is the spark that ignites change. So, if you are looking for fundraising, this article will surely clear all your queries. This article also concentrates on the interaction that we follow for startups and organizations hoping to raise support fundamentally through selling some equity.

Private Equity is a capital investment firm that is not listed on any public stock exchange, and the risk involved is low and is required for the expansion of business and growth of the firm. A venture capital fund is generally invested in the initial stage by the individual or investor, which helps the company grow in the initial period. According to the survey, 51% of startups said that their next source of funds was venture capital. The funding starts from bootstrapping, in which one can use their own money or family, or friend’s money. The other method of funding is through the seed round where angel investors are available for the seed funding.

Importance of Fundraising

Fundraising plays a crucial role for the startup. It can increase visibility and attracts the attention of the market. It can get additional value from the investor. Lack of capital is the main reason for the failure of many small businesses. To reach a larger audience in the market and compete with the other players, businesses need money to grow and increase their sales and marketing efforts. In today’s time, there is a positive trend in startup business funding.

Five Steps of Fundraising are:

Steps in Fundraising for Venture Capital or Private Equity Fund

Steps in Fundraising for Venture Capital or Private Equity Fund

Build up the firm

Before starting the fundraising, the firm should build up its profile, improve its website, strengthen its online presence on social media, and check its marketing toolkit and legal structure. It will not raise the fund if the firm is a proprietary company, partnership company, or limited liability partnership. Only the private limited company gets the funding from the PE or VC firm. So first, one must correct the legal structure of one’s business for raising funds and then build the core team, hire the advisory board, and invest in a graphic designer to make the website and business logo. Any limited partner prefers to see a strong portfolio and professional presence of the company.

Private placement memorandum

It is a legal disclosure agreement prepared by the companies and given to an investor for their capital. Creating a private placement memorandum is also essential for the investor. It mainly focuses on gaining long-term capital appreciation through the control investment. This document must include a detailed message about the athletic background, investment strategy, opportunity, and risk.

Research and analysis

Comprehensive research about market reach, market size, and the number of potential customers is done. What is a company’s breakeven, return on investment, and how much is the revenue and profitability of the company? The company vision and plan should be clear. The company should prepare a budget sheet and prepare certain specific questions related to the budget sheet which the investor may ask. The company should check all the financial and legal details before reaching out to the investor. The company should influence how the firm has a competitive advantage and how it will optimize the resources and use it in the best possible way. It also involves doing detailed research and finding the right investors according to one’s industry. Many investment bankers provide investment to the firm, so finding the right investor according to your business is essential. One will easily raise the fund when one gets the right kind of investor, Consequently the company valuation will also increase.

Pitch deck

This is a document where the company should prepare the details about the team member, the company, competition, business model, financials, plans to expand, patent, strategy, etc. and then it is presented to the investor. The pitch deck should be attractive so that investors agree to invest in the business. It must include the return on the investment and how one can expand the company, and future income projections. The investor should see the profitability and the scope of the companies he will prefer to invest in. The goals and objective of the fund, why investment is needed, and where you will support the amount should be clarified. A competitive landscape, marketing opportunities, and detailed information about the shareholder should be necessary.

The investor needs to know how the company’s valuation will grow. The format of the pitch deck should be significant. The pitch to the investor should be professional. The companies should prepare before giving a final rise to the investor so that the last pitch to the investor should be appealing and realistic.

Due Diligence

It is the investigation and review performed to check the process of all the financial and legal documents produced before the investor. The investor should verify all the company’s claims and evaluate the business, check the economic situation, compound annual growth rate, liquidity ratio, profit margin, previous loan, or funding. Due diligence is a necessary process, and the company should clarify or answer all the doubts and questions of the investor. The company should arrange all the documents before going to the investor pitch and do due diligence because if the company misses any records, the funding may not be approved. In this process, the company signs a binding agreement.

Due Diligence process:

A due diligence process is an organized checklist to analyze the company ownership and organization, financial ratio, legal documents, shareholder value, future growth potential, and management. These documents are mandatory for a smooth process and should be prepared before starting the fundraising process.

Due Diligence for Private Equity

Due Diligence for Private Equity

The due diligence package includes the following documents:

-Subscription agreement

-Summary of the contract

-Name of the advisor to the fund

-Sample report

-Asset allocation

-Estimated timeline

-Investment transaction

-Management references

-A pipeline of deals

-The risk mitigation

-Conflict of interest.

Term Sheet

The term sheet includes all details related to the terms and conditions of the agreement. It is issued by the investor, in which detailed information about the company valuation, percentage stake, investor commitment, and liquidity preferences, the right of both parties, how much capital should be invested are mentioned.

The shareholder agreement is also issued, which is the detailed version of the term sheet that mentions all the details of the duties, right, jurisdiction, and arbitration of the company. The share subscription agreement should also explain the share and company stake terms.

These documents should be made so that it does not lead to a legal battle if any. Negotiation is also crucial. The investor generally negotiates more to cut the company’s valuation. The firm should take care of that. Investor relations also play an essential role and set the company’s credibility. If the relationship is good, then it may attract the other investor. The company should also explain the report, growth, and the new project to the existing investor. So, if the company is invested in the relationship, it will undoubtedly benefit in the long run.

 The five steps, as mentioned above, are simple to raise funds. Raising money through venture capital and private equity in series funding is mentioned in the article. Generally, raising funds for the first time for a startup is quite tricky, and it needs a good network, so outsourcing the fundraising support is needed.

Magistral’s Services on Fundraising

 Magistral consulting offers solutions in the following categories –

Fundraising Documentation

Magistral consulting prepares all documents that are helpful in fundraising. It also includes polishing the material to ensure the papers’ standards and design.

Magistral’s investor database

Magistral consulting database help to find the right kind of investor. There are more than 25K+ records of investors.

Specialized lead generation

For business-to-business development particular lead generation program is generated.

Analyst support

Magistral consulting ensures analyst support at every fundraising step. 

About Magistral Consulting

Magistral Consulting has helped multiple funds and companies in outsourcing operations activities. It has service offerings for Private Equity, Venture Capital, Family Offices, Investment Banks, Asset Managers, Hedge Funds, Financial Consultants, Real Estate, REITs, RE funds, Corporates and Portfolio companies. Its functional expertise is around Deal origination, Deal Execution, Due Diligence, Financial Modeling, Portfolio Management and Equity Research.

For setting up an appointment with a Magistral representative visit www.magistralconsulting.com/contact

About the Author

The article is Authored by Marketing Department of Magistral Consulting. For any business inquiries, you could reach out to prabhash.choudhary@magistralconsulting.com

What is Due Diligence?

Due Diligence Definition: It is an exercise done to check the quality of an investment before committing funds to it. There are lots of claims that are made by an asset manager, a company founder, a real estate developer, or anyone else who is interested in selling the asset or a stake of it thereof. These claims need to be satisfactorily validated before the funds are committed to buying the asset or a part of it.

 

Due Diligence in Finance

Due diligence is a general term of analyzing the investment before committing the funds. Financial due diligence concerns with the assets that generate returns and are financial in nature like private or public companies, start-ups, hedge funds, real estate, and real estate funds.

 

What does due diligence consist of?

Due diligence for financial aspects validates the claims of the seller through a detailed study of the documentation supporting the sellers’ claims. The Due Diligence period depends on the size and the nature of the asset on which it is being performed. The speed at which the data is made available also impacts the Due Diligence period. A start-up which is a small set-up could be checked in say a few weeks’ time, whereas bigger corporates may take months before the exercise for the whole company is performed.

Due Diligence Process

The process sometimes may take long periods and may require expertise. An external consultant can be hired for a Due diligence fee to make the process more objective

Here are the steps that are required for a detailed Due Diligence exercise:

Establishing the purpose of the investment

The investor needs to identify the purpose of the investment to do due diligence on the relevant aspects of the financial assets. For example, an investor wants to invest in a start-up with an aim of explosive growth in the next few years, so that he could exit the investment with massive gains. Or another investor wants to invest in a Real Estate fund specializing in infrastructure to generate a regular flow of income. Establishing the purpose clarifies the areas where the due diligence should be focused on. This leads to the development of the Due Diligence framework

Identifying the focus areas for Due Diligence

Once the purpose is established, investors should identify their focus areas for due diligence accordingly. In the above example say for the start-up the future growth is very important. What are the factors on which the future growth would depend? These are the market in which the start-up operates, its competition, its product, the capability of the team, etc. Similarly, for the Real Estate investment, the quality of underlying assets is important so that the investor could be assured of regular returns. This leads to doing due diligence on the type and quality of investments done by the RE fund, contracts signed, leases, rent rolls, tenants, users, market conditions, and everything else that may have an impact on the RE yield, where the fund operates

Preparing Due Diligence Questionnaires

A questionnaire needs to be prepared for each focus area. The way it works is that one starts with a broad question and set of other supporting questions. The questionnaire is followed by the collection of all the relevant data and documents. The seller provides the due diligence documents through data rooms, that could be physical or virtual. Investors or their representatives go through the details of all the data and documents and ask for clarifications if that is so required. A Due diligence checklist is also prepared to find out all the relevant supporting documents. A Due Diligence Analyst keeps track of the documents in the data room and the actions completed.

Preparing Due Diligence Report

Once the study of all the data and documents is complete, the service provider prepares a due diligence report for the investors. It carries all the details about the investments, outcomes that could reasonably be expected from the investments, and red flags that the investor should be concerned about. Some reports clearly suggest if the investor should go ahead with the investment at all

Magistral Consulting has experience in conducting due diligence for start-ups, private companies, public companies, and funds. It covers all aspects of due diligence done by Private Equity, Venture Capital, Investment Banks, Family Offices, and Fund of Funds. Here are the broad types of Due Diligence

Types of Financial Due Diligence

Various types of Due Diligence performed by Investment Banks, Private Equity, Venture Capital and Family Office firms

Due Diligence of a Company

Due diligence for companies is typically done before investing in or Mergers and Acquisitions of companies. This is also done before buying a business. The areas covered in the process largely depend on the size of the company and the purpose of the investment. While doing due diligence for companies, the following are the areas that should be looked into

Financial Performance-Past and Forecast

This is very critical for bigger companies. As usually the investments are done for returns from stocks, which is directly related to the expected financial performance of the company. It also impacts company valuation and stock price. Past financial performance is pulled out and compared with regulatory filings. Also studied are the market, trends, cyclicity, inventory, and other financial aspects. P&L and balance sheets are dived into to find any outliers. This is compared with peers in the same industry to look for anything that may raise suspicion. Forecast assumptions are checked for validity. Departmental budgets are scrutinized for authenticity and to find improvement potential. Previous audit reports are seen for regularly repeated observations. Usually, for start-ups, this is not a critical factor, as they are still in process of streamlining the revenue sources. Still, for start-ups that are looking to raise funds beyond seed or Series A, it’s imperative to get into the details of financials.

Strategy

Another aspect of companies that need closer careful evaluation is their strategy. The growth rates of the markets, and product categories, it plans to expand into is closely studied. It is checked if the current portfolio of its products and services is the most favorable from cost and growth perspectives. Risks are also evaluated along with the competition of the company. In the case of Start-ups and smaller companies, growth rates, competition and trends are looked into closely to verify the assumptions made while valuing the company

Operations

various other functions of the company are also studied under this like Manufacturing, Procurement, Human Resources, Technology, etc. It is evaluated with a lens of efficiency and cost. This is to evaluate the scope of operational efficiency in case the ownership of the company changes hands. Again this is not so important for smaller or start-up companies.

Team

Due diligence on the team is very important for start-up companies. Their experience, skills, qualifications, and past achievements are looked into to have a comprehensive view of their capabilities and future potential. This factor is not that important in the case of large companies where this exercise is being done for M&A

Product

This is very important for SaaS-based tech start-ups. The product needs to be checked as to where is it in the development stage. If it is fully developed, whether its UI, features, etc. are working properly. If not how much time and effort will go into developing the product. Is there even a chance of whether the team will ever be able to develop the product? For bigger companies, the entire portfolio of the product is studied to find out winners

Customers

In the case of B2B health of the biggest clients is checked out to suggest the sustainability of the market for the company. In the case of the B2C demographic profile and its future changes are analyzed to understand any revenue impact in the future. For SaaS-based tech companies, the nature of customers is understood whether they are free, freemium, or paid and the average ticket price to understand the sustainability of the business in the long run

Due Diligence of Funds

Due diligence of funds is usually done by Fund of Funds, Family Offices, and other investors who are interested in investing in the fund. The process, in this case, is different from the  process followed in case of companies

Activities of Due Diligence

Major differences between due diligence of companies and funds

Here are the items that are looked at while performing due diligence for the funds

Fund Performance

This is true for both Real Estate and Hedge Funds. All the technical parameters related to the fund performance are looked at while making a decision.  This evaluates not only the returns that the fund has generated in the past but also the volatility and the risk taken to produce those returns. Funds’ performance is benchmarked with the indices that carry no investment risks

 

Team

Here the profile of Fund Managers is looked into. Their experience qualification and past performance are looked into while evaluating the team. This is again true for both Hedge Funds and Real Estate funds

 

Investment Focus

The investment focus of the fund is analyzed to see if it is in line with the expectations of the investor. If it is a hedge fund that its markets, stocks, and geography are considered whereas if it is a Real Estate fund then the Real Estate Class and geography are considered for the exercise.

 

Underlying Portfolio

This is slightly more important in the case of Due Diligence of Real Estate funds as compared to Hedge funds as the Hedge Fund portfolio churns more often, whereas the Real Estate portfolio is more or less permanent. The quality of the underlying portfolio is looked at for the potential of generating regular returns. If there are any red flags in any of the properties, the same is highlighted. Real Estate properties and assets are analyzed for price trends, forecasts, rent, value increase, neighborhoods, and future potential of the asset.

Markets

This is more relevant for niche Real Estate funds that are dealing in specialist RE categories like handicap hostels or Self-storage. The potential in the underlying theme is objectively evaluated to find out the potential of returns that could be generated in the future

 

Magistral has experience and capabilities in providing Due Diligence Services to global clients in the space of Private Equity, Venture Capital, Investment Banking, and Family Offices

About Magistral

Magistral Consulting has helped multiple funds and companies in outsourcing operations activities. It has service offerings for Private Equity, Venture Capital, Family Offices, Investment Banks, Asset Managers, Hedge Funds, Financial Consultants, Real Estate, REITs, RE funds, Corporates and Portfolio companies. Its functional expertise is around Deal origination, Deal Execution, Due Diligence, Financial Modeling, Portfolio Management and Equity Research

For setting up an appointment with a Magistral representative visit www.magistralconsulting.com/contact

About the Author

The Author, Prabhash Choudhary is the CEO of Magistral Consulting and can be reached at Prabhash.choudhary@magistralconsutling.com for any queries or business inquiries.