Pre Investment Due Diligence

Many companies want to get the support of strong and stable investors, because it is an opportunity to accelerate growth, implement new ideas, quickly restructure the business and increase capital. In search of a source, organizations create entire teams that try to display their best qualities to clients. But it is worth removing the screen of positive graphs of these “talkers”, as there is a threat of seeing a completely different situation.

The fact is that very often companies try to attract investors to an already sinking ship and hope for a saving chance of investment. Unfortunately, in 2 cases out of 3 there is a losing combination for the investor. In order not to fall into the trap, investors need to stop listening to “fairy tales” and just look at the results of Pre Investment Due Diligence.

The Pre Investment Due Diligence Process

Potential investors only need to analyze 5 aspects to have enough information to make a confident decision. These are the things they should pay attention to:

  • Accounting and Finance. The first thing the experts need to do is estimate the actual budget. It is better to look at this for a certain period of time. The numbers will immediately show whether the company is profitable or unprofitable. The financial cut for the quarter will show the potential for growth/decline in capital in the future.
  • Team Skills. It is necessary to pay attention to who and how the company is managed, how quickly and how many successful decisions were made. In this case, it will not hurt to be honest about failures. This is valuable experience, which will help in the future. It is also necessary to assess the structure of the entire team, the experience, and qualifications of the available specialists.
  • Market and competitors. It should not be forgotten that the market is fickle. It is important to study trends and the mood of consumers to assess further demand. As for competitors, it is necessary to try to analyze how they are developing and what struggles they have to overcome. Whether it will be feasible at all.
  • Relationship with the law. Consider the situation in the field of law about the presence of the company and any unresolved conflicts. It is possible that the situation has been resolved for the moment, but there are precedents for future problems.  
  • SWOT analysis. It is a simple but effective method that shows the positive and negative qualities. It also predicts future threats and opportunities for development and expansion.
  • Based on this information, it will be easier for investors to decide whether to drop the idea at once or spend more time and effort exploring it deeper.

Evaluating Financial Health

The financial situation of a company, the amount of capital invested, and indicators of stability are a clear demonstration of what the chances of success and development can be. Analysts collect data, analyze it and summarize it into a certain economic coefficient. This measurement scale has a certain flexibility, but a number of documents are examined to determine it.

Liquidity

At the beginning of the analysis, there is no need to look at the long term if there is significant difficulty in meeting debt obligations in the short term. If the company is required to make payments that it does not have now, then the liquidity ratio is less than “1” and this is a threat. 

See also  Due Diligence Software

Shareholders or creditors

The next item after liquidity is analyzing solvency. The main stock of finances can be kept by shareholders or creditors. If debt obligations are mostly met by shareholders’ money, this is a good indicator. But if the main burden depends on the money of creditors, it is already a problem. 

Efficiency

The calculation is based on cost and profit indicators in order to see if there are unfavorable offers, dependence on partners and possible irrational expenses. This result will show the quality of the leaders’ management activities and the overall organization of the company.

Profitability

The company has revenue and that’s good. But financiers distinguish such a concept as “Net Margin”. In simple words, the company makes a profit. Part of this profit will go to cover expenses, and part of the money is needed for further work of the organization. The part of the money that remains in the pocket of the company and is free is called ‘Net Profit’. This is important because many companies have huge revenue and, at the same time, a minimal margin. In such a case, the business is not ready for significant growth or unexpected challenges. 

This is one of the classic schemes where investors learn step by step about a company’s ability to survive, grow and make money.

Operational Assessment

This type of inspection is aimed at assessing and looking for internal weaknesses in the company that are related to production or operations. Experts pay attention to such things as:

  • Rationality of the use of premises
  • Technical condition of the equipment used
  • The relevance of the equipment used
  • Placement of employees and equipment of workplaces
  • Scheme of internal traffic routes (communication between shops or departments)
  • Quantity and quality of various units
  • Territorial and general efficiency of work
  • Coherence of all processes 
  • And others.

In addition to the assessment, the experts prepare recommendations on what and how to improve in order to obtain the highest efficiency index. This allows investors to understand whether the situation can be improved now and whether it will be possible in the future. 

What You Need to Know Before Investing – Key Insights

This meticulous process, undertaken before committing capital, aims to mitigate risks and maximize returns. But what exactly comprises pre-investment due diligence? This analysis delves into the key aspects investors need to understand before making an investment.

Firstly, pre-investment due diligence focuses on the financial health of the potential investment. This involves not just scrutinizing numbers but interpreting them to identify any financial red flags. This process assesses financial statements, cash flow projections, and balance sheets. Investors must be aware of existing liabilities and how they might impact future growth, ensuring the investment does not jeopardize their current portfolio.

Another critical component is examining the fund’s strategy. Investors need to determine whether the investment aligns with their financial goals. Understanding the fund’s strategy is crucial to gauge whether the risk-reward profile fits their objectives. Additionally, evaluating the expertise and background of the fund managers is vital. The competence of fund managers can significantly influence investment outcomes, underscoring the importance of thorough due diligence.

Pre-investment due diligence also involves analyzing the market conditions affecting the investment. Market dynamics and economic conditions play significant roles in determining the potential success of an investment. Therefore, investors must consider industry trends, regulatory changes, and competitive landscapes. This comprehensive overview ensures that investors are not caught off guard by unforeseen market shifts.

See also  Transactional Due Diligence

Moreover, pre-investment due diligence includes litigation checks. Investigating any legal battles or regulatory issues surrounding the investment or its managers is essential. Litigation risks can deplete the fund’s resources and damage its reputation. Hence, this aspect of due diligence acts as a safeguard against potential legal pitfalls.

Evaluating the operational aspects of the investment is another important element. This includes scrutinizing the business model, growth strategies, and any operational inefficiencies that might pose risks. Fund managers demonstrating robust operational structures can instill confidence in potential investors during the due diligence phase.

Equity structures and ownership rights also form a crucial part of pre-investment due diligence. Investors need clarity on equity distributions and any preferential treatments within the investment. This clarity helps investors understand their position within the investment hierarchy and anticipate their returns.

Lastly, the significance of conducting environmental, social, and governance (ESG) due diligence is growing. Investors increasingly consider ESG criteria to ensure their investments are not only profitable but also socially responsible. This holistic approach to due diligence reflects a sustainable and ethical investment ethos.

A Unique Perspective

Chris Sacca is one of the most successful investors with extensive experience. He has significantly improved his financial situation by investing in companies like Uber or Twitter. Chris tells us why a preliminary valuation is so important for investments. 

This analysis allows you to assess your own financial prospects when cooperating with the chosen company. Also, such a check allows you to determine what amount of investment would be reasonable.

In addition, Sacca said that looking for “red flags” helps to determine the real probability of risk and see hidden troubles. Through vivid examples, he demonstrated how the first investor’s return would drop from 4.76% to 4.28% if another participant showed up. 

Strategic Due Diligence

In order to safeguard investments, investors include several other indicators in their due diligence. These include:

  • Situation in the market: this examines the company’s ability to solve the problem of customers, the ratio of supply and demand, and the region of activity.
  • Competitiveness: an assessment is made of the number of similar players in the required area of activity and their level of development. The key to this question is the ability of the invested company to overtake the existing leaders. 
  • Company aspirations: it is necessary to understand what the company aspires to, how long and far it is ready to move in development, and whether shareholders and creditors are ready to provide active support.
  • History of previous investors: knowledge about the success of predecessors will help to complete the picture of prospects for the future.

Each of the details can provide new clues and a more transparent view of the prospects.  

Summary

Anyone would be happy to invest $100 and get $1,000 a month later. But who would be willing to invest $10,000 and only get $100 for it a year later? Due diligence refers to the risk of losing the investment and the risk of getting pennies. An analysis will show what the amount may be, how many risks and adverse factors may jeopardize the investment, and how quickly to expect rewards.