Strong Fundamentals

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Deal with DD

Matthew Bradley

Investor @ Forward Partners

Due diligence for the top decile. The investment meetings have been concluded. Terms have been offered and negotiated. The founder has chosen the best money from the investor pageant. Then this is roughly how things go down as the investment process moves to post-termsheet purgatory. The feeling is often shared by the VCs that the founder is working with. But why? Both founders and investors are (presumably) keen to get back to the actual day-to-day of the business: to join forces in building a great company. For some reason, this common goal is often not enough to ensure a smooth, speedy progression through DD. I expect that, much like a good deal of bumps in the road, the problem is down to a lack of prior knowledge and/or poor communication. Let’s try and solve this issue.

Key takeaways

  1. Think strategically, achieve simplicity
  2. Don’t over over-optimise on terms, that’s not the core of the business
  3. The unfamiliar is scary, prepare for the process beforehand

* founder signs termsheet 😎  

** breathes a sigh of relief having made a life-changing decision 😌  

*** gets presented a list of DD requirements with accompanying sinking feeling 🙁  

At Forward Partners, we’re investors at the earliest possible stage - backing solo founders, pre-revenue, pre-product, pre-pre-pre while being active at seed and then following on through the Series’. We have a relatively light-touch DD process as is appropriate for the stages that we lead rounds but it’s also a reflection of something more deep rooted: simplicity is key.

Our DD process falls into three general categories: getting to know you (the founder(s)) more, getting to know your company more and agreeing legals and key documents. This is a framework that will play out no matter what stage you take on investment or have an exit.

Getting to know you

Understanding how founders tick is key. What they’ve done in the past and how they’ve set up their company in the present are strong indicators of the entrepreneurs and personalities behind the business. So that we can assess this we have a founder questionnaire. This is a largely semi freeform document where founders tell us about their past experiences, give us their ID, plus a number of yes/no questions which feed back into the founder warranties / investor protections in the legals. It’s 4 pages long and shouldn’t take more than a couple of hours to complete. We do some background checks and make a few reference calls. I typically ask for ~8 possible references from different periods of the founder’s life and then choose 3. It’s harder for people to ‘game’ the system that way. I love doing reference calls. Partly because I’m super nosey and love to ask questions, but it’s also an opportunity to hear more about the person behind the pitch. As far as possible I like to have a collaborative relationship from the first handshake to the last though inevitably until deals are complete: game-faces persist. Reference calls give an incredibly valuable window as to who you are and that’s something that I really care about.  

Getting to know your company

We have another questionnaire which drives this aspect. It’s >95% yes/no so even though it's 14 pages it shouldn’t take any longer than the Founder Questionnaire to complete. The responses here also feed into investor protections but they also give us a view on how organised the setup of the business is. We are looking to see how the business has been funded to date, what the financial statements look like and who has key contracts with the business and what form they take. This process also gives us insights as to whether IP, brand, company values and legal and business and infrastructure have been thought about strategically. We also do some technical DD to evaluate the scalability of the tech-stack where relevant. It’s through this process that we see the degree of organisation of individuals and teams when you get past ‘front of house’. We understand that paperwork and laying foundations isn’t everyone’s strength but if you’re well organised investors will welcome it. Good organisation will pay dividends throughout a company’s lifecycle but no more than at nascent stages where founders have to do a lot of critical tasks themselves. It’s great when we see a level of attention and long-term thinking which has been applied to ensuring that a business has the best possible start in life.

You would be amazed how often, even at the very early stages that we operate in, you come across odd decision making. Whether it’s a dirty contract with an agency/freelancer or a ‘1-stop-shop’ company set up, settlements (or otherwise) with old employees/founding members, pricey loans, expensive lawyer bills, the list goes on.

Agreeing legals and key documents

There are a number important documents that we need to see in place before completing investments and transferring the $£€. Strong, futureproofed employment contracts are a must for an institutional investor if they don’t already exist. Though it’s the Shareholders & Subscription Agreements and the Articles of Association which take up the most time. For us, we have very standard looking termsheets and the legals reflect this simplicity and their content. Much like we don’t like to be surprised by negative things, nor do we wish to serve founders something that they weren’t expecting.

There are often a few bumps in the road here too. Unless the founder is an experienced deal do’er either in an entrepreneurial or corporate capacity this is where legal and accounting counsel can be a great help and/or a hindrance. A top grade service-provider will understand that there’s an equilibrium between getting the best deal for their client and getting things done quickly so that business as usual can be resumed. A less experienced or less helpful counsel may be short-termist and optimise their own paycheck: encouraging prolonged negotiations, rephrasing, additions and removals, etc. It’s hard to know whether you’re in ‘prolonged negotiations’ when you’re a part of them, so if you suspect that this might be going on the best thing to do is to ask other founders, investors or experienced folk for their opinions or experience.

How to navigate post-termsheet purgatory

Good investors care deeply about you and your business. We want, more than anything else, to return to focusing on the business and building something great. We don’t do what we do to optimise on terms, rather we want to optimise on ultimate outcome and we hope that founders do too. That is best achieved through a slick, professional attitude to DD. Here are some tips to making a success of the process

  • Simplicity. Focus on it. Simplicity is a signal of quality, strategic thinking...and it begets value creation. The benefits of this will be realised in later funding rounds and at exit.

  • Index on speed of execution. It’s better to have a smaller piece of a bigger pie. That’s true for us and that’s true for founders. Establish key areas of debate quickly. Discuss, decide, move on. Implicit in this is high quality, high velocity communication. I tend to use WhatsApp to keep the process moving as quickly as possible. It may be less formal, but it’s synchronous...which makes a big difference.

  • The unfamiliar is scary. I’ve seen a number of founders clam-up when it gets to legals. I believe that this is a function of a lack of familiarity. Founders can avoid this by taking online courses, seeking advice from contemporaries. An important part of this is doing your DD on the investor beforehand. Know what to expect with regard to their specific DD procedure before you get presented with the materials. Prepare for the process.

  • Get a lawyer that you can trust. Move away from a service-provider/consumer relationship and develop a ‘trusted advisor’ rapport. You’ll be able to align your deal team to focus on the important issues for your business rather focus leaking to non value-additive practises.

Due diligence is a process of getting to know people and their businesses better. It can be protracted and painful and some debate is inevitable. Focus on the end goal and work back from there. That’ll grease the wheels and get everyone pulling in the same direction as quickly as possible.

Further Reading:


Matthew Bradley

Investor @ Forward Partners

Matthew used to work on trading floors at Lloyds and BarCap before seeing the light. Following an MBA at SDA Bocconi and before joining us he became an entrepreneur and investor in his own right. He’s focused on sourcing and executing deals. His other interests and activities include investment strategy, writing and emoji.

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