Have you ever had doubts about a certain investment decision? Or have you ever hesitated about how to properly evaluate a counterparty so as not to risk your business? If so, this article will definitely catch your attention.
Step 1: What is due diligence?
Let’s start with what can be considered due diligence in investing. Due Diligence is the process of evaluating an investment by an investor. It is the so-called “detailed investigation”. Whether you want to invest your money in a start-up company or a well-established company, it is important to start with the first stage – the Due Diligence process. As you can see from the name, “Due” means properly. After conducting Due Diligence, you, as an investor, will be able to make a smart and well-informed investment decision. Due Diligence will help you identify “red flags” and offer a strategic roadmap after the acquisition to increase investment success.
The Due Diligence process involves various factors that you should pay special attention to. If you do not pay attention to at least one factor during this process, it can have harmful consequences for your investment funds. Our lawyers pay special attention when conducting Due Diligence for our clients. Therefore, in this article we would like to “lift the curtain” and shed light on some hidden pitfalls.
Step 2: Analysis of corporate documents
The Due Diligence process begins with an analysis of all the documents available in the company (the object of your investment). For example, it is very important to request corporate documents that confirm the legal existence of the company: Memorandum and Articles of Association, Certificate of Incorporation, Extract from the Trade Register, Certificate of Legal Existence (also known as COLE). These documents can prove that the company is active, as you will know its registered name, address, legal form, date of incorporation, directors.
Step 3: Company Services
The next step is to assess the company’s position in the market: does the company provide B2B or B2C services, who are its main customers and suppliers? A comprehensive market analysis plays an important role in determining the full range of services that the company provides to its customers. See how the company performs the KYC & KYB procedure. (If you are interested in learning more about the KYC & KYB procedure, click here and start reading)
In addition, it may be advisable to review the company’s standard classification code (KVED) and check whether it corresponds to the project in which you intend to invest. For example, if the company’s KVED is related to marketing, and your investment is focused on a software development project, the question may arise as to what purposes the founders intend to use the invested amount…. This key factor is important for clarifying the main areas of activity of the company.
Step 4: Company Assets
Asset analysis makes a significant contribution to the overall valuation of a company. A comprehensive asset analysis allows you to assess risks such as encumbrances, insolvency or debts of the company. After examining the company’s assets, investors can assess how efficiently the company is using its resources, as companies with productive and high-quality assets have a better chance of growing and generating profits in the future.
Step 5: Founders, Shareholders and Directors
The next step in the Due Diligence process is to analyze the founders, shareholders and directors of the company. Before investing, it is important to evaluate the experience and qualifications of the founders. Study their previous experience, major core businesses, acquired businesses. Pay attention to social media tools: LinkedIn or Facebook can provide you with additional information about the founders. You can analyze their experience by searching on LinkedIn or other social networks. Gather resumes of founders, shareholders, and directors to gain a complete picture of their qualifications and achievements. Public records and databases can help an investor analyze whether the founders’ previous business management was successful or failed. Thus, this is valuable information about the founders’ capabilities and reliability.
Step 6: Company Product
The next key factor on which Due Diligence is based is the assessment of the company’s core product. When conducting Due Diligence, it is very important to understand whether the product is ready to be an “industry leader.” This step includes assessing the company’s operational capabilities, market positioning, and value proposition.
Step 7: License
The next key factor to consider is examining all the legal requirements for the company to function in the jurisdiction in which it operates. For example, if a company operates as a gambling operator, it is clear that it must obtain the necessary license for legal activities. Therefore, it is extremely important to pay attention to the issue of obtaining the appropriate permits to ensure compliance with applicable legislation.
Step 9: Labor Issues
During the Due Diligence procedure, an investor may have a question about the importance of assessing the company’s staffing level. At first glance, this may seem unnecessary, but the workforce is considered a key indicator of the company’s overall performance. As the quote says: “The most valuable resource is people.”
In general, by assessing the number of company personnel, an investor gets an idea of the company’s internal processes, management hierarchy and business strategy.
For example, if a company specializes in software development, its employees must be appropriate: front-end developers, back-end developers, java developers, etc. If the company’s staffing is not up to par, this may indicate high risks for your investment.
If the company works mainly with private entrepreneurs, you can freely request service contracts to verify the scope of work provided by private entrepreneurs. If the services provided do not coincide with the company’s core business, “red flags” may arise and investment risk will arise. A key factor to consider: always pay attention to the NDA, NCA and NSA clauses in the agreements. They are fundamental in protecting the company’s business interests, because in the event of litigation.
Ultimately, Due Diligence acts as a “safety net” that prevents unforeseen operational problems from arising in the investment process.
Step 10: Deep Dive into Financial Health
To analyze the financial health of an investee, it is very important to request the company’s financial statements. This will allow you to get an accurate idea of where the majority of the investee’s assets are concentrated. Particular attention should be paid to the financial institutions in which the company has accounts, as well as the payment providers it uses. The so-called “deep dive into the financial health” of a company allows you to assess the company’s profitability, debt level and future projections.
Step 11: Business plan or illusory scenario?
Many business ideas arose on a wave of passion, but even the most passionate ideas may not always be so realistic, even with proper financing. That is why the next key factor to consider is the company’s business plan. It outlines all the necessary information about the company’s goals and objectives, development strategy, potential challenges, opportunities and progress. Why is this “leap” so important? As an investor, it allows you to analyze the stages of the company’s development, how it plans to develop and predict the potential consequences of the project’s success or unfavorable scenario. As an investor, you will be able to track the company’s progress, assess the achievement of its milestones and determine whether this particular project is the worst to finance. After you have read the business plan, in the final conclusion, the founders must convince the investor that their project deserves your attention and that it is viable in the long term.
Step 12: In-depth legal check of intellectual property
Intellectual property (IP) is a key factor that an investor should carefully consider when revealing the intrinsic value of the investment object. Imagine that you are investing in an IT company that provides its customers with online services. From an investor’s perspective, it is particularly beneficial to invest in a company that owns the rights to the project’s platform code, has ownership of the domain, patents, or a registered trademark of its commercial brand. Ownership protects the company from complex challenges, such as third-party claims for intellectual property infringement or misleading trademark use. A registered trademark protects the company’s brands and strengthens its position in the market, offering a competitive advantage over competitors. (If you are interested in the procedure for international trademark registration, follow the link and read our article on this topic).
By investing in a company with reliable IP protection, you as an investor protect your interests from potential risks. Make sure you have conducted a comprehensive review of all intellectual property-related documents, such as intellectual property transfer agreements, contracts, licenses, employment contracts for the presence of intellectual property transfer clauses, as well as patent applications and trademark applications that are pending in the courts. Our company can provide you with a detailed IP portfolio to highlight all the strengths and weaknesses of the investment company.
Step 13: Lawsuits, Fines and Sanctions
When conducting Due Diligence, you need to be aware of all the shortcomings of the company. Every business has its critics, but nevertheless, you should understand the market conditions surrounding your investment object. Start by studying the relevant information. Use keywords such as “fines”, “credits”, “liquidation”, “scandals” to identify all the pitfalls of the company that create its “reputation” in the market. You always have the opportunity to search for information on the Internet. You can also use social media tools to collect additional information about the company: professional bloggers always publish popular scandals, thereby forming a useful source of information.
Step 14: Conclusion
In general, a qualified Due Diligence procedure is extremely important, as it helps the investor to make an important investment decision and be confident that the project will achieve its investment goals after receiving financing. Therefore, in order to prevent unforeseen issues that may arise during the investment procedure, we recommend conducting a Due Diligence procedure in advance. Our sought-after specialist will be happy to help you with this!
