Corporate Due Diligence of Startups in M&A Transactions and Funding

Beyond the Numbers:  Corporate Due Diligence of Startups in Merger & Acquisition Transactions and Funding.

Start-up companies present greater risk than more established businesses to investors and potential buyers. One of the best ways to mitigate the risk is to augment your due diligence team with an objective analysis from a third party valuation and due diligence expert.

Forensic accountants and financial investigators experienced in corporate due diligence of start-ups will provide valuable insight into your transaction. Their purpose is to minimize post-acquisition or post-funding surprises. The use of a forensic accountant is often overlooked when acquiring or funding start-up companies. Many people say you don’t need to perform due diligence of startups because there’s nothing to find.  That’s a mistake many learn only after the transaction is complete and the start-up fails to deliver on its promise.

The general types of information and documentation reviewed in relation to more established businesses include: organizational documents, tangible and intangible property, forecasting and marketing plans, contracts and commitments, pending or potential litigation, company structure and organizational charts, board of director meeting notes, affiliations, certifications, capitalization table, and debt schedules to name a few.

The due diligence performed on a start-up is not as complex or comprehensive as with an established business and may not include all the above. In some cases, the startup will be in the R&D phase and will have very few if any of the above. Therefore, the latent risks are greater primarily because you have less information and established data to work with. When examining a startup, your due diligence investigators may have to get creative to make the most of the limited information available. When examining a startup your due diligence professionals may:

  • Analyze growth prospects. This includes a thoughtful and candid analysis of the startup’s competitiveness. Is there demand for their service? If so, what is the startup doing or planning to do that will set them apart from the field? Do they have realistic goals?
  • Examine the accuracy of financial disclosures.
  • Investigate evidence of latent facts and circumstances (e.g. fraud, conflicts of interest, understated liabilities).
  • Verify the accuracy of reported and/or potential revenue streams and expenses.
  • Review the company tax structure and position.
  • Conduct a full background investigation of the company’s key leaders including prior business engagements, liabilities, assets, expertise, education, credentials, and professional experience.
  • Interview the company’s current and past customers to gauge customer service experience and opportunities for improvement.
  • Interview employees and managers to gauge company morale and leadership competency.
  • Determining human capital inefficiencies.

In summary, corporate due diligence should be a key component of any M&A and private investment strategy particularly when dealing with start-up companies.  Ensure your due diligence team deploys a multi-disciplinary team to maximize the return on your investment.

 

William Foster

Co-founder & Managing Partner

Smith & Foster LLC

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