We recently held a due diligence seminar where we reviewed the due diligence we’d undertaken on three investee companies – one that failed, one that was a near miss (we didn’t invest) and one that’s a recent investment. We took the approach of ‘knowing what we know now’, what we did well and not so well when we undertook due diligence. 40 of our members participated in workshops in Tauranga and Hamilton. Not rocket science but I thought I’d share two of the key insights.
We always get a list from the investee company of suppliers, customers, professional advisers etc… so we can validate aspects of the due diligence. We’ll also speak to people not referred by the company. These can include industry experts and people/businesses in the company’s target market who aren’t currently customers.
In the case of the near miss, it was the due diligence team’s research of existing customers’ feedback that was highly influential in investors deciding not to invest. The company went into liquidation shortly thereafter.
A couple of key points: we always inform the company that we will be contacting parties not referred by them. It’s also very important that the due diligence team handles these conversations sensitively and sensibly. No one wants to cause damage to the company. For entrepreneurs reading this – it’s not that we don’t trust you, but would you invest half a million dollars without doing some of your own digging? I didn’t think so.
Yeah I know – we must have rocks in our heads investing in early stage manufacturers. Doing so certainly runs counter to most early stage investing which is in IT. But we are confident we will get it right – we just haven’t managed to on two of our manufacturing investee companies so far (ouch!).
The challenge is that the cash burn rate is so much higher in a manufacturer than it is in IT. Therefore you have a lot less room for mistakes and pivots. And what early stage business doesn’t have plenty of both.
So, learnings from our failed manufacturer. A lot or work has to be done on product development and market validation before you produce that first widget. Once you are manufacturing, building stock and incurring overhead, you better have a very clear, well-oiled path to customers with no product stuff ups.
And, what we’d also be looking for is strong validation that the prospective acquirer(s) of the company, or licensees of the technology, are identified and engaged. We want to manufacture just enough units to get the acquirer or licensee to step in and take on the capital intensive work of scaling production.