Finding the Cash in Due Diligence

(page 2 of 2)

How does the customer make a decision to buy your product or service? How long does the decision-making process take? Why would they pick you over a competitor?

3. How is the product sold? Direct? Indirect? What is the likelihood of significant market adoption? How would you achieve this? In what period of time?

4. How is the product or service priced? What are the cost of goods sold (COGS)? How healthy are the margins?

5. How will the business reach the identified customer segments? (Please don't say "It'll be viral!" because it's unclear what that means. A while back, I met a CEO who said his social networking site would have 5 million registered users within its first year. But he had no plan for how he'd achieve this. Hey, I'm all for "virality," but let's be real. Maybe you'll be like one startup I worked with who signed up several dozen "community builders" by giving each one 200 shares of fully vested stock and a list of performance expectations. The community builders were chartered with bringing both content and friends to the site over the first year (or longer, if they wanted). They were recruited because they were influencers, connectors, mavens, enthusiasts. It worked—the startup hit its first million registered users in the first year of this program. And for a few thousand shares—such a deal.

6. How much will it cost in time and resources to acquire a customer? How much does it cost to support a customer? How easy is it to retain a customer?

7. How are you with milestones? Show us your past performance and specify future milestones. Then tell us when you'll achieve them and boost our confidence with your track record.

8. What's your exit strategy? We'll be paying attention to see if the executive team agrees on this.

Phase III: Searching for Show Stoppers

Right on! You've made it through Phase II. Everyone's feeling good, but now is not the time to get cocky. This is precisely when the naysayers try to kill the deal. Prevent this from happening by eliminating the following risks:

1. Harmful pre-existing agreements. The funding source needs to know what has been promised to whom, as they'll have to help deliver it. Be straight with them. If they're on board, they may be able to untangle some messy contracts.

2. Unsettled management team issues. Nothing kills a deal faster. If the team isn't cohesive, the funding source won't want to clean up the mess. Handle this before you seek out a source.

3. Disruptive or complex shareholder issues: I recently looked at a deal ("Company X") for about five minutes—then I ran screaming. The problem: 73% of ownership was in the hands of a silent foreign investor. Silent? Maybe. Able to sway any stock class vote? Absolutely. The company wanted VC or angel funding to clean up their capital structure—but a VC or angel wouldn't invest in it as is—it's too messy.

4. Inadequate intellectual-property protection or ownership issues: Back to the Company X example above: The IP (which would comprise the entire product line) was set to be acquired via the anticipated financing round. But would the financing happen, only to have the still silent and the majority shareholder nix the IP acquisition? Wait a sec—what exactly was a financier supposed to invest in? A shell company that had big dreams? Yep. The startup needed to hire a boutique investment bank to do the initial fundraising (which really was a leveraged buyout), clean up the shareholder and IP issues, then seek VCs or angels.

5. Excessive current liabilities. Been spending too much? Funding sources will be gone. They want to finance the future, not pay for your past.

6. Inappropriate use of proceeds: Be realistic about where you'll spend the money. Tell your investor, then stick to the plan, or seek out advice if the plan changes.

7. Regulatory issues: Anything scary or requiring excessive bureaucracy? Does your company require FDA approval? Special licenses to operate? How hard are these to get?

If you get through the above, you'll be well on your way to securing a fabulous financing. I'll dive into the heads of financiers in future columns, where I'll talk about the key people, finance, sales/marketing, and technology risks of funding a company.

Christine Comaford, CEO of business accelerator Mighty Ventures is the author of the best-selling book Rules for Renegades. She invites you to participate in her next Q&A call by registering at www.AskChristineNow.com. She writes her column on small business growth strategies every other week.