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Due diligence in the world of investing is really another way of saying: “take reasonable care before committing your money”.
Given how often startups fail, it’s obviously crucially important that you do your due diligence prior to investing in them. After all, if you invest in a startup that emerges as a winner – then significant profits lie down the line.
At Bure Valley Group, we connect exciting, high-potential startups looking for funding with our exclusive network of investors – who are looking for the next big thing. These businesses must pass through a stringent set of criteria, tests and vetting before we present their proposal to our network. So it’s fair to say, we know a good thing or two about startup due diligence!
So in this guide, we’ll be sharing some tips with you from our experience, about how to do some of your own due diligence when looking to invest in startups:
#1 Check the Overall Presented Facts
When you speak with a startup seeking funding from you as an investor, it’s imperative that you never take anything at face value. Always check the claims and facts presented to you:
- Size of team / number of employees
- Background, skills and experience of the team members
- Stories about the startup and employees in the news / social media
- Trading record
- Credibility of the sector
And more. These are just a handful of the claims and facts you must check by yourself. It’s in your interests to do so. After all, nobody wants to commit money based on inflated or inaccurate facts about an investment. Few things sting as much as losing money in this situation.
Doing due diligence actually helps the startup in question, as well. After all, this process might actually reveal something to the business that they’d not seen or thought about, which they can then correct in order to strengthen their position.
#2 Use Companies House, but Know its Limits
Most people know that if you want to access the accounts of a UK company, you do so through Companies House. The Beta gives you instant access, but there are some problems.
First, there’s the time lag. On Companies House, accounts for a 12-month trading period do not need to be filed until 9 months after this period. So, if a startup began trading in January 2018, then their accounts up to December 2018 do not need to be filed until September 2019. This obviously creates a problem for investors looking to do their account due diligence.
Second, businesses are able to shift their filing date – something you can trace through Companies House. If a startup’s director(s) do this, then you need to ask them what the reason is for changing the filing date. Are they hiding something, or is there a credible reason?
Third, many startups are not actually required to file accounts on Companies House. They can choose to do so, but alternatively they can submit an unaudited balance sheet (provided the business meets certain qualifying criteria).
In short, you cannot rely on a balance sheet to determine a startup’s financial health. Make sure you get hold of the business’s full accounts, and be certain to check these against any accounts filed online. If you find any inaccuracies or inconsistencies, then you’d be wise to not invest.
#3 Check the Company Directors
If there’s one strong determinant of a startup’s prospects of success or failure, it would be its director(s). Yet it isn’t always straightforward doing due diligence on them.
For example, suppose you are interested in investing in a startup and the company director’s name is “John Philip Patrick Greene.” Checking the Company Register, you could use any combination of these names and initials, and it would throw the full name up.
What does this mean? It means that it is possible for one person to have multiple entries on the Company Register. They would just need to use different ways of writing their forenames or initials. It isn’t illegal, but it does leave the door open for people to use it illegally.
There are all sorts of horror stories out there. Startup company directors who have listed multiple versions of their name on the Company Register, some of which list liquidated companies. Yet the version of the name given in the funding pitch was different.
To ensure you do not miss this, make sure you do not just search the Company Register by name. Also use the person’s date of birth. This is much more likely to be entered correctly, as providing incorrect information here would be against the law.
LinkedIn is also a very useful source to check company directors, as is Google Search and Google News. Make sure you cross-check the person using multiple sources, and ask them directly about any inconsistencies you find.
#4 Check the Market
Startups occupy a distinct landscape within the market. Or at least, they are supposed to.
Make sure you do your own market analysis. Really drill down on the market segment, as looking too broadly will not give you enough information.
A good example is the car market. There are numerous segments involved here. It is largely irrelevant, for instance, to look at UK-wide car sales when the product you’re looking at is an electric car aimed at city-dwellers.
Ensure you also do your own research on the company’s competition. It’s completely conceivable that the startup might have missed some in their pitch.
Check the company’s scalability. They might well have had a first-year turnover of £100,000, and claim that there is enough of a market for that to become £1.5m in the next 12 months. Assuming that occurs, do they have the processes in place to handle that turnover?
Another area to consider is the M&A levels and behaviour in the startup’s sector. This can have a big impact on your profitability prospects as an investor. Check Google for a M&A report in the sector you’re looking at. In all likelihood, there will be a recent one out there. Just make sure you are certain of the figures and sources used before relying on it.
There is much more to startup due diligence than what we’ve outlined above, but hopefully this gives you some food for thought.
If you are an investor interested in accessing our latest, qualified funding proposals, or a business looking for funding, please get in touch.