Due diligence tips for SMEs looking for venture capital
Small and medium sized businesses are eager to find the funding they need to carry out expansion through mergers and acquisitions. But how do owners of SMEs and start-ups make sure their investors are the real deal?
Most small business owners are learning that carrying out a thorough due diligence process on any prospective investor can really help to increase the chances that the deal will be a success. Much of the investment in SMEs comes from venture capitalists and it is this type of investor we will focus on here. Below are some guidelines for due diligence of venture capitalists that can help business owners to identify risks, potential liabilities and weaknesses in their investor.
1. Check social networks for background on a venture capitalist. These days, there’s a wealth of information out there that can help people to spot potential risks and problems with a prospective investor. Business owners can use sites like LinkedIn to find out which others firms the investor has partnered with. These partners can then be contacted a quizzed about their experience.
2. It’s also a good idea for entrepreneurs to find out if their venture capitalists has experience in their industry. It’s always preferable for an investor to understand the businesses or at least the industries it partners with. Prior investments can give this information away, as can general due diligence question-asking. If the investor does not understand the businesses they may expect return on their investment within a time-frame that is simply not achievable in the market, for example. Start-ups, in particular, need do make sure they are on the same page with their investor in terms of ROI – keeping in mind restraints such as time-to-market.
3. Taking every opportunity to network with other entrepreneurs and small business owners will help most to establish whether accepting the help of a venture capitalist is for them. Talking to those who have accepted investment, as well as those who have not, will enable owners to gain a balanced perspective on the topic. If any of these new contacts can provide references to other firms that accepted venture capital, it’s a good idea to personally visit these new contacts as part of the due diligence process.
4. Aggressive terms should sound an alarm in business owners’ ears and a venture capitalist that insists on restrictive or high liquidation preferences should be viewed with caution. It is likely that SMEs that are seeking investment may consider mergers in the future and, in if this were to occur, business owners need to make sure they are not left liable for massive payouts to their venture capitalists. These kinds of aggressive terms are becoming more common in light of the current economic climate, but any terms that could threaten a small companies’ future ability to conduct M&A should be rejected.
5. If an entrepreneur does decide to take the plunge and accept investment from a venture capitalist, they should get busy establishing good relationships with this new partner. Making sure there is a contact at the venture capitalist that knows their business should be a priority for any business owner.
Once this ‘chemistry’ between investor and business has been established, there is no reason why such as partnership shouldn’t be mutually beneficial for many years.