VC Due Diligence

Investors have an unlimited amount of companies that they are able to invest in but it is usually the the investor that finds it’s niche or focuses on a specific market that usually comes out on top.   If an investor is trying to invest in 10 different companies that are all in different market segments then it is highly unlikely that the VC firm will have the expertise needed in all of these different markets to truly provide a value add for the company.

In deciding on specific companies to invest in I think the investor needs to first become comfortable and knowledgeable about the market in which the potential company operates in.  The investor has to be sure that is, or there will be, a large enough market for the companies product or service.  Next the investor will have to create a relationship with the management team as discussed in the post “Both Sides of the Table” by Mark Suster.  This is because as an investor you are not only putting your money into just a company but also making a bet on skill and drive of the management team.

Items that an investor would like to see when performing due diligence vary widely from investor to investor but a few are at the top of the list for most.  The first box I would like to see checked when performing due diligence would be some assurance as the current entrepreneur’s plan to stay with the company/product for the long term.  I would not invest in a company that has a flaky owner who is likely to to jump ship as soon as I invest or the company isn’t developing as planned.  Another due diligence item at the top of my list would be my determination if the product/service is truly innovative and has a high growth potential.  Investing this early in companies it is truly impossible to tell if the product/service offered will be a hit in the future but one must try to the best of their ability to try forecast it.  As a VC investor I am looking for an extremely large return down the road to compensate for the risk I am taking on and thus I will have to be able to convince myself this company will provide these large gains in the future.

There is no set rules when performing due diligence it is truly different for each investor. But the overall factor is the investor must get comfortable with the investment in their own way.  For some investors it is a gut feeling, others it may be they like the entrepreneur  and others it may be purely quantitative and driven by financials only.

Venture Capital Terminology

      There really were not any new terminology or phrases that I was unaware of after class and watching the video.  I have watched the video once already last year and am currently working for a private equity firm and am familiar with most all terms presented.  But there have been a few terms presented that I researched a little more to understand their true meanings as I have heard them used but never knew their exact meanings.

Many times a VC, PE, or even banks will use the term syndication when describing how a deal will be funded.  Syndication is essentially a word meaning splitting up the investment between 2 or more investment groups.  It could also be used when a bank provides financing and does not want to keep the entire amount in house, they will syndicate a portion of the loan and allow other banks to lend alongside them.

A term sheet is usually the very starting point of any deal.  These term sheets include the basic terms of the deal and are almost always non-binding.  Term sheets are constructed to get both party’s ideas of how the deal will be structured in writing.

Dry powder is a term that refers to capital that a firm has that is ready to be invested.  Sometimes a firm will indicate they have a fund of X millions but many times all that amount is technically not “dry” powder because some of it will be earmarked for investments to be made or amounts from it will be already invested.

When someone in the VC community refers to a “follow-on” investment it usually refers to a second stage investment by the same firm.  

Saying you invested on the ground floor or got in on the ground floor describes getting in during the very early days of the company.