By Omoruyi Edoigiawerie, Esq
This week I conclude my article on Understanding due diligence for start-up investment, the first part of the article was published penultimate week, and this second part will review the team dynamics, technology and product market fit, the legal structure, and an analysis of the steps taken in the due diligence process.
*The team
The start-up’s team is often a critical factor in its success. Evaluating the team involves looking at their background, experience, and track record. I like to group the team analysis into three subheads:
a. Founders and key executives: it is important to assess the founders’ and executives’ experience, skills, and previous achievements. Strong leadership with relevant expertise increases the likelihood of success. The question here to ask, is what the track record of these founders and executives are? This will give you an overview of their experience trajectory.
b. Team dynamics: Evaluate the team’s cohesion and dynamics. A well-functioning team with complementary skills is crucial for executing the startup’s vision, what is the team composition, strength, and work culture? Do they embody the right team spirit? Or do they work in silos? What is the reward mechanism in place? And how does the Startup balance competitive output with teamwork?
c. Board structure: Review the composition of the board, both statutory and advisory boards. Experienced and reputable members on the board bring valuable guidance and enhance the startup’s credibility.
*Product and technology
The second key aspect to consider is the Product and Technology. Understanding the startup’s product or technology is vital, especially for tech-focused ventures. To do this properly, it is important to segment them into the following stages:
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a. Product development stage: in this stage, you determine the stage of product development. Is it an idea, prototype, or market-ready product? The development stage determines the level of risk and potential of the investment.
b. Technology assessment: under this stage, it is important to evaluate the core technology. Querying its level of innovation and assessing the feasibility and scalability of the technology. Another key consideration is to ascertain the level of intellectual property (IP) protection that is in place and the contracting and agreement framework that surrounds the process flow around the creation of the product.
c. Product-market fit: This perhaps is the most critical of the three considerations, it is necessary to analyze the product’s market fit. Does it address a significant pain point or need in the market? One way of establishing this is spaced and encompassing positive customer feedback and product traction, these will indicate strong market fit and where it is absent, increase the risk of investment.
*Legal and regulatory compliance
Ensuring legal and regulatory compliance during startup investment due diligence is crucial for mitigating risks and safeguarding the investment. This process involves a thorough review of the startup’s adherence to relevant laws and regulations, including corporate governance, intellectual property rights, employment laws, and industry-specific regulations.
Investors must scrutinize the startup’s legal documents (incorporation, licenses, and permits), contracts, and any pending or potential litigation to identify any red flags. Additionally, compliance with financial regulations and tax obligations should be verified to prevent future liabilities. A comprehensive legal audit ensures that all regulatory requirements are met, fostering a transparent and secure investment environment.
*Steps in the due diligence process
The due diligence process typically involves several steps, each designed to gather and analyze relevant information.
1. Preliminary evaluation
Start with a preliminary evaluation to identify if the startup aligns with your investment criteria or thesis. This involves reviewing pitch decks, executive summaries, and initial conversations with the founders.
2. Detailed investigation
Once the preliminary evaluation is positive, proceed to a detailed investigation. This involves an in-depth analysis of the key areas mentioned above. Request comprehensive documentation and data from the start-up.
3. Site visits and meetings
Conduct site visits and meetings with the startup’s team. This provides firsthand insights into the company’s operations, culture, and working environment. Face-to-face meetings with the founders and key team members can reveal much about their passion, vision, and teamwork.
4. External verification
Verify the information provided by the startup through external sources. This may include customer references, market research, legal/security audits, and technical evaluations. External verification helps confirm the accuracy and reliability of the startup’s claims.
5. Risk assessment and valuation
Assess the risks identified during the due diligence process and factor them into your investment decision. Use the information gathered to determine a fair valuation for the startup. Consider both the potential upside and the risks involved.
6. Negotiation and final decision
Based on the due diligence findings, negotiate the terms of the investment. This includes the investment amount, equity stake, governance rights, and any contingencies. Once terms are agreed upon, make the final investment decision.
*Conclusion
Due diligence is a critical component of the start-up investment process. It helps investors make informed decisions, mitigate risks, and ensure that their investments are based on solid foundations. As the start-up ecosystem continues to grow, the importance of a detailed due diligence process cannot be overemphasised in driving successful investment outcomes.
*Omoruyi Edoigiawerie is the Founder and Lead Partner at Edoigiawerie & Company LP, a full-service law firm offering bespoke legal services with a focus on start-ups, established businesses, and upscale private clients in Nigeria. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. His firm can be reached by email at hello@uyilaw.com
