Slide 1
Class 7 Notes
Due Diligence Part 1
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 2
Agenda
•
Homework due tonight
•
•
•
•
•
•
Midterm Evaluations
Diligence Overview
•
•
•
Teams email – did you send it?
Confidentiality Agreement – did you sign it?
Gurus in the Garage
Question Card C
Harvard Model
Market, Competition, and Comparables
Gurus in the Garage
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 3
Iraq Revisited
More information?
What is Bush doing?
While England Slept revisited?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 4
Diligence
Defining Diligence,
Frameworks and Performing Diligence,
Issues in Diligence
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 5
Definition of Diligence
•
Macro: Researching a company to determine:
•
•
•
•
Whether to commit to making an investment
The size of the commitment
The terms and conditions of the commitment
Micro: Researching a company to determine:
•
•
•
•
70-397 Venture Finance
Risks and opportunities
Unknowns
Future needs of time, people, money
Metrics for measuring success
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 6
What Makes Doable Diligence?
•
Do you have access to the right resources?
•
•
•
•
Primary research
Secondary research
Leveraging the company
Do you have the right expertise?
•
•
70-397 Venture Finance
Investment Model revisited
What deals have you done?
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 7
What Makes Good Diligence?
•
Addresses a single point of the decision
•
In a timely and economic fashion
•
And provides a clear answer
70-397 Venture Finance
Fall 2002
© William Hulley
Slide 8
Marks of “Good” Diligence
•
It asks a single question
•
•
•
•
The question:
•
•
•
•
•
Is this a good CEO?
Does the product work as advertised?
Who is the competition?
Addresses a risk or opportunity
Verifies a fact
Answers an unknown
Frames an uncertainty
Can be addressed in a timely and economic manner
70-397 Venture Finance
Fall 2002
© William Hulley
Slide 9
Definitions of a Diligence Framework
•
•
•
A target list of areas to evaluate in considering any
investment opportunity
A formal description of the rules used to judge any
investment opportunity
An attempt to rationalize ad hoc decisions about an
investment opportunity
70-397 Venture Finance
Fall 2002
© William Hulley
Slide 10
Why Create a Framework?
•
Know what questions to ask on any deal
•
Insure deal to deal evaluation consistency
•
Set expectations, time frames and goals
•
Limit emotion, politics, selling
•
Understand the post-deal milestones, effort
70-397 Venture Finance
Fall 2002
© William Hulley
Slide 11
The Harvard Framework
People
Context
Deal
Business Opportunity
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 12
People
•
The Entrepreneur
•
•
•
•
The Management Team
•
•
•
“An A-quality [person] with a B-quality project, but not the
other way around.” General Georges Doroit
With limited resources, a major mistake will kill the
company
Honesty, integrity and reliability are sacrosanct
Relevant skill set
Commitment
The Stakeholders: who is around the deal?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 13
The Business Opportunity
•
The Model
•
•
•
•
•
Customer: benefit vs. cost
Size:
•
•
•
•
Short version of how the business will make money
Why will customers part with their cash?
Market size, value proposition, profit potential, sustainable
advantage
What is the upside?
Winning investors don’t do deals that lack the potential for
substantial returns because the risk is losing everything is high
Scale and/or scope
Timing
•
•
70-397 Venture Finance
Are the customers ready?
What are the customers doing now and what may come along
later?
Fall 2002
© Andrew W. Hannah
Slide 14
Context
•
•
•
What apart from entrepreneur and management team actions,
can hurt or help this venture?
The Economy
Technology
•
•
•
•
“I would say that it is important to divorce the notion of cool
technology from one that is likely to be accepted by the market.”
Steve McGeady, Intel
Stage: can customer now do something they couldn’t before or is
there a dramatic cost reduction?
Regulation
Competition: If there is no competition, there is no market!
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 15
Evaluating the Deal
The evaluation is the great time killer: 40 +hours
•
People
•
•
•
•
•
Stakeholders
The team
Entrepreneur
•
•
•
Business Opportunity
•
•
•
•
Deal
Context
•
Size
The model
Customer
Timing
Price
Structure
•
•
•
The economy
Technology
Regulation
Competition
How would you rank order these?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 16
Understanding Risk
•
•
•
•
•
•
•
•
Technological risk
Product/service risk
Market risk
Sales risk
Competitive risk
Financing risk
Operating risk
People risk
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 17
Summary
•
Investment decisions come in two flavors
•
•
•
Good diligence
•
•
•
•
Addresses a single point of the investment decision
In a timely and economic fashion
And provides a clear answer
Good frameworks
•
•
•
•
The Macro - Should I, how much, what terms?
The Micro - What are the risks, opportunities, unknowns?
Are useful across many deals
Clearly define what they do
Demonstrate their value at the micro and macro level
Understand the risks
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 18
Market Diligence
•
Why does it matter?
•
Revenue potential
•
•
•
Units and pricing matter
Market growth and shrinkage matter
What are the supporting questions?
•
•
•
•
70-397 Venture Finance
Who is the customer?
How many are there?
How much money do they spend on products like this?
What else competes for that budget?
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 19
Market Diligence (Cont.)
•
Identify Sources of Information
•
•
•
•
•
•
•
•
Company information
Competitors product and company information
Analysts
Magazine
Regulatory filings
Trade associations
Customers
Define format for reporting (see handout)
•
•
•
70-397 Venture Finance
Question
Source – who, what, when
Answer
Fall 2002
© Andrew W. Hannah and William Hulley
Slide 20
Gurus in the Garage Discussion
•
What are the themes?
•
•
•
•
•
•
•
Can the entrepreneur do it alone?
What does that say about how you perform due diligence
on the entrepreneur?
What does that say about geography?
What does that say about industry clustering?
Can mentor capitalists be harmful?
What is the most important role of a mentor
capitalist?
Is the Valley the “one and only”
•
70-397 Venture Finance
What could kill the valley?
Fall 2002
© Andrew W. Hannah
Slide 21
Next Week
•
Venture Capitalist on Due Diligence
•
•
•
•
Diligence Card “A”
In Three Weeks (moved from 10/22 to 10/29)
•
•
•
Craig Gomulka, Draper Triangle
How VC’s do due diligence
Diligence Card “B” – comparables
Read the PolyTronics business plan
WA: 114 – 141 (this is different than the syllabus)
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah