Has the deal been shopped around to many investors, each of whom rejected it?
An eighth screening mechanism used by many venture capitalists is to determine whether deals have been "shopped," that is, whether they have been presented to and been passed over by other investors. Venture capitalists generally avoids shopped deals. Properly employed, this strategy makes a lot of sense. Shopped deals, by difinition, have been reviewed and rejected several times by other venture capitalists. If a particular venture capitalist trusts the business and investment judgment of another investor who rejected the deal, there s no reason that the former should not rely on the latter's negative due diligence. However, rejecting a deal solely because it was shopped, without finding out who rejected the deal and why it was rejected, could result in the venture capitalist missing a great opportunity. Twenty venture capitalists turned down Hotmail before Draper Fisher Jurvetson ivested; Hotmail was later sold to microsoft ofr over $400 million.
Friday, January 22, 2010
Monday, January 18, 2010
Quality of customers and/or partners
Has the company signed any impressive customers and/or partners?
One thing that often get a company quickly past the screening phase of due diligence is the ability to list an impressive customer or two, or to have inked a deal with a strategically valuable partner. The venture capitalists at Oak Investment Partners state that they look for "distinctive relationships that have been formed with customers or partners that give (them) good visibility into the near future." The ability to close important deals in indicative of the ability to succeed, especially in the early stages, where one key deal can make or break a company. Closing such deals also demonstrates momentum. Companies that can sign one important deal usually have a much easier time signing the next, and the next, just as a snowball builds mass quickly once its starts rolling. Therefore, venture capitalists tend to be strongly drawn to companies that can demonstrate they are just beginning to roll.
It is certainly most impressive when such deals have been finalized, but venture capitalists also are interested in those for which companies have only received letters of intent. LOIs are usually non binding, but they lay the foundation for final deals by spelling out their principal terms. They are often an important and necessary intermediate step toward finalizing deals, and companies that obtain them offer strong evidence that the other party is seriously interested in striking a deal.
One thing that often get a company quickly past the screening phase of due diligence is the ability to list an impressive customer or two, or to have inked a deal with a strategically valuable partner. The venture capitalists at Oak Investment Partners state that they look for "distinctive relationships that have been formed with customers or partners that give (them) good visibility into the near future." The ability to close important deals in indicative of the ability to succeed, especially in the early stages, where one key deal can make or break a company. Closing such deals also demonstrates momentum. Companies that can sign one important deal usually have a much easier time signing the next, and the next, just as a snowball builds mass quickly once its starts rolling. Therefore, venture capitalists tend to be strongly drawn to companies that can demonstrate they are just beginning to roll.
It is certainly most impressive when such deals have been finalized, but venture capitalists also are interested in those for which companies have only received letters of intent. LOIs are usually non binding, but they lay the foundation for final deals by spelling out their principal terms. They are often an important and necessary intermediate step toward finalizing deals, and companies that obtain them offer strong evidence that the other party is seriously interested in striking a deal.
Wednesday, January 13, 2010
Screening due diligence #6 Quality of the origin
Does the origin of the company conform to successful patterns?
A sixth screening mechanism used by some venture capitalists involves an examination of companies' origins. They feel much more comfortable with companies whose origins resemble those with whom they have met success in the past - that confirm to successful and familiar patterns. For example, venture capitalists are used to backing companies started by well-known executives who have to backing companies started by well-known executives who have "spun out" of established, market-leading companies, or by well-known university professors who have developed cutting-edge innovations, or by hungry and brilliant graduate students who have happened on the "next big thing" during their studies. Companies with these origins, and others conforming to other patterns of success, tend to find venture backing relatively easily. On the other hand, companies that have questionable or unusual origins may find that venture capitalists are very tight-fisted. Recognizing patterns of success makes sense for venture capitalists, because parrern, by their nature, repeat themselves; all things being equal, companies whose origins conform to successful patterns tend to be success themselves.
A sixth screening mechanism used by some venture capitalists involves an examination of companies' origins. They feel much more comfortable with companies whose origins resemble those with whom they have met success in the past - that confirm to successful and familiar patterns. For example, venture capitalists are used to backing companies started by well-known executives who have to backing companies started by well-known executives who have "spun out" of established, market-leading companies, or by well-known university professors who have developed cutting-edge innovations, or by hungry and brilliant graduate students who have happened on the "next big thing" during their studies. Companies with these origins, and others conforming to other patterns of success, tend to find venture backing relatively easily. On the other hand, companies that have questionable or unusual origins may find that venture capitalists are very tight-fisted. Recognizing patterns of success makes sense for venture capitalists, because parrern, by their nature, repeat themselves; all things being equal, companies whose origins conform to successful patterns tend to be success themselves.
Monday, October 26, 2009
We capitalized them...
An executive says to his VC partner in the above cartoon, "What burns my bottom about www.dazoosucks.com is that we capitalized them."
Sunday, October 25, 2009
Screening due diligence #5: Quality of accounting firm?
Who is the company's accounting firm?
Early stage companies also need quality accounting advice and assistance to function and grow effectively. This generally involves three basic services. First, the law requires all companies to file tax returns, and accounting firms can certainly aid in that area. And, outsourcing tax preparation often makes a lot of sense for young companies because it allows them to focus on their real task: building their companies. Second, many early-stage companies can benefit significantly from assistance with bookkeeping. Indeed, a well-designed book-keeping system is crucial to effective early-stage management. And, third, early-stage companies will, at some point, require auditing services. Auditing services can facilitate further venture financing, bank financing, and financing in the public markets, and can often aid in forging customer relationships.
Furthermore, like their legal counterparts, venture-oriented accounting firms offer services beyond traditional accounting type services. As Jeffry A Timmons, professor at the Harvard Business School, points out:
Accountants who are experienced as advisors to emerging companies can provide, in addition to audit and taxation, other valuable services. An experienced general business advisor can be invaluable in helping to think through strategy, in helping to find a right VC.
Early stage companies also need quality accounting advice and assistance to function and grow effectively. This generally involves three basic services. First, the law requires all companies to file tax returns, and accounting firms can certainly aid in that area. And, outsourcing tax preparation often makes a lot of sense for young companies because it allows them to focus on their real task: building their companies. Second, many early-stage companies can benefit significantly from assistance with bookkeeping. Indeed, a well-designed book-keeping system is crucial to effective early-stage management. And, third, early-stage companies will, at some point, require auditing services. Auditing services can facilitate further venture financing, bank financing, and financing in the public markets, and can often aid in forging customer relationships.
Furthermore, like their legal counterparts, venture-oriented accounting firms offer services beyond traditional accounting type services. As Jeffry A Timmons, professor at the Harvard Business School, points out:
Accountants who are experienced as advisors to emerging companies can provide, in addition to audit and taxation, other valuable services. An experienced general business advisor can be invaluable in helping to think through strategy, in helping to find a right VC.
Saturday, October 24, 2009
Screening due diligence #4: Quality of Legal Counsel
Who is the company's legal counsel?
To be successful, early-stage companies need good legal counsel. The road from start-up through high growth to successful maturity is much too hazardous to forge ahead without a high-quality and appropriately experienced law firm on board. On one hand, law firms provide vital legal services such as creating corporate structure, addressing employment issues, and advising on contract negotiations. Companies receiving sound, quality legal advice in these areas certainly increase their likelihood of success. Regarding contracts, the venture capitalists at Accel Partners state that the "corporate contracts demanded of new companies grow geometrically - distribution agreements, employment agreements, financial agreements, patent agreements - and mistakes on any of them can seriously jeopardize a company's ultimate value. Even minor errors can require inordinate top management attention." On the other hand, law firms also often provide other services to early-stage companies, such as giving advice on business plan construction and financing strategy, and making introductions to venture capital firms, bankers, accounting firms, and consultants. Receiving this assistance from experienced and well connected lawyers can also boost a company's likelihood of success. Therefore, a fourth screening mechanism sometimes used by some venture capitalists is to evaluate the quality of companies' legal counsel.
Determining the quality of law firms is not always easy for venture investors, but, as Christopher Schaelpe, general partner of Weiss, Peck & Greer Venture Partners, explains, there are only "on the order of 15 major law firms throughout the country with a core competence in advising private high-technology companies'. In Silicon Valley, this fraternity includes Wilson Sonsini Goodrich & Rosati; the Venture Law Group; Cooley Godward; Gunderson Detmer; Fenwick & West; Brobeck Phleger & Harrison; Heller Ehrman White & McAuliffe; and Gray Cary Ware & Freidenrich. In Boston, it includes Hale & Dorr; Testa Hurwitz & Thibeault; and Edwards & Angell. In New York, it includes Skadden Arps Slate Meagher & Flom; O'Sullivan Graev & Karabell; Reboul MacMurray Hewit Maynard & Kristol. In Seattle, it includes Perkins Coie.
To be successful, early-stage companies need good legal counsel. The road from start-up through high growth to successful maturity is much too hazardous to forge ahead without a high-quality and appropriately experienced law firm on board. On one hand, law firms provide vital legal services such as creating corporate structure, addressing employment issues, and advising on contract negotiations. Companies receiving sound, quality legal advice in these areas certainly increase their likelihood of success. Regarding contracts, the venture capitalists at Accel Partners state that the "corporate contracts demanded of new companies grow geometrically - distribution agreements, employment agreements, financial agreements, patent agreements - and mistakes on any of them can seriously jeopardize a company's ultimate value. Even minor errors can require inordinate top management attention." On the other hand, law firms also often provide other services to early-stage companies, such as giving advice on business plan construction and financing strategy, and making introductions to venture capital firms, bankers, accounting firms, and consultants. Receiving this assistance from experienced and well connected lawyers can also boost a company's likelihood of success. Therefore, a fourth screening mechanism sometimes used by some venture capitalists is to evaluate the quality of companies' legal counsel.
Determining the quality of law firms is not always easy for venture investors, but, as Christopher Schaelpe, general partner of Weiss, Peck & Greer Venture Partners, explains, there are only "on the order of 15 major law firms throughout the country with a core competence in advising private high-technology companies'. In Silicon Valley, this fraternity includes Wilson Sonsini Goodrich & Rosati; the Venture Law Group; Cooley Godward; Gunderson Detmer; Fenwick & West; Brobeck Phleger & Harrison; Heller Ehrman White & McAuliffe; and Gray Cary Ware & Freidenrich. In Boston, it includes Hale & Dorr; Testa Hurwitz & Thibeault; and Edwards & Angell. In New York, it includes Skadden Arps Slate Meagher & Flom; O'Sullivan Graev & Karabell; Reboul MacMurray Hewit Maynard & Kristol. In Seattle, it includes Perkins Coie.
Friday, October 23, 2009
Screening due diligence #3: Quality of Other Equity Investors
Who are the company's existing investors, and who are the potential co-investors?
Venture capitalists also often focus on the quality of companies' existing equity investors and potential current round coinvestors as a third screening mechanism. They do this for two reasons. First, an impressive investor list is often indicative of a good investment. Simply put, great companies attract high-quality investors. Conversely, a company's inability to find any high-quality investors suggests that an investment may not be a very promising one. Second, high-quality investors often contribute significantly to their companies' success. Depending on the particular investors, they may provide any or all of the following to their portfolio companies: general business knowledge, operating experience, and business reputation. Equity investors may also bring to their portfolio companies extended networks of contacts to mangement recruits, service providers (law firms, accounting firms, public relation firms, etc.) customers, suppliers, strategic partners, venture capitalists, potential acquirers, and/or investment bankers.
A somewhat related point that some venture capitalists examine during due diligence is whether, and to what extent, existing equity investors will participate in the current round of financing. The failure of existing investors to support the company may dramatically reduce interest on the part of venture capitalists because existing investors often have unique information about the companies in which they hold equity. Almost surely, they have more high-quality information than that available to potential investors, even after thorough due diligence. Accordingly, if existing investors choose not to participate fully in subsequent rounds, it may quite possibly be the result of problems not visible to potential investors.
Venture capitalists also often focus on the quality of companies' existing equity investors and potential current round coinvestors as a third screening mechanism. They do this for two reasons. First, an impressive investor list is often indicative of a good investment. Simply put, great companies attract high-quality investors. Conversely, a company's inability to find any high-quality investors suggests that an investment may not be a very promising one. Second, high-quality investors often contribute significantly to their companies' success. Depending on the particular investors, they may provide any or all of the following to their portfolio companies: general business knowledge, operating experience, and business reputation. Equity investors may also bring to their portfolio companies extended networks of contacts to mangement recruits, service providers (law firms, accounting firms, public relation firms, etc.) customers, suppliers, strategic partners, venture capitalists, potential acquirers, and/or investment bankers.
A somewhat related point that some venture capitalists examine during due diligence is whether, and to what extent, existing equity investors will participate in the current round of financing. The failure of existing investors to support the company may dramatically reduce interest on the part of venture capitalists because existing investors often have unique information about the companies in which they hold equity. Almost surely, they have more high-quality information than that available to potential investors, even after thorough due diligence. Accordingly, if existing investors choose not to participate fully in subsequent rounds, it may quite possibly be the result of problems not visible to potential investors.
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