Friday, November 6, 2015

Marginal Burn versus Opportunity Loss - Founder's Dilemma?

Founders of growth stage companies face plenty of dilemmas while deciding on allocating precious resources. Particularly while hiring their senior management team. Often, to save money, they end up hiring smart people who may not have the relevant experience but are willing to experiment and learn. At a stage when the company is trying to take off, this can be an expensive experiment.

I recently attended a Board meeting at one of our fast growing portfolio company. New sign up rate was at all time high but so was churn. A deeper dive into causes of churn revealed that it was mostly during onboarding phase. Once onboarded properly, with a human touch, customers stayed for long. It quickly became apparent that we needed to hire more people in support for new customers. The fact that this discussion happened at the Board level worried me because CEO himself was trying to solve the problem. His deputy who was responsible for customer success was in that role for 6 months and yet the fast growing company was experimenting with support. I questioned the experience and skill set of the customer success manager and was explained by the CEO that such experience is not available locally and would be expensive to hire someone with relevant experience.

Founder was obviously concerned about the marginal burn that the company would incur if someone with relevant experience was hunted and hired. But the founder had quietly accepted the opportunity loss that the company would have to bear because that was not clearly visible. Company's monthly burn was S$150K and hiring someone relevant would have costed additional S$10-15K.

This was not the first time. Last year, one of the startup was looking to hire a COO to share the burden with Founder and during the search process, I saw the Founder to be very cautious with COO salary range. They were lucky to get smart people at the price but not many of them had relevant experience. The new hires had to test and learn from scratch and eventually costed the company more.

Dilemma of marginal burn can also be seen while deciding on marginal marketing spend. Founder of another startup was not prepared to experiment with increasing the marketing burn. Their marketing budget was about 10% of their monthly burn of S$80-90K.  And, they would not experiment burning another S$20-30K in additional marketing/PR.

I understand that it all adds up when you increase marginal spend in all areas simultaneously. But a decision has to be taken considering - "Marginal burn is visible but Opportunity Loss is not."

Are you going with the safer option? Be mindful of the opportunity loss.

Thursday, May 21, 2015

How to structure a FUNCTIONAL Board ?

Do you feel excited about the upcoming board meeting? Do you feel that the hours spent with your Board members are worth more than the money they invested? Do you ever wish that if it was possible to hire those Board members as part of your team? Or
Are you one of those founders who think Board meetings are a complete waste of time? Do you wish that the frequency of Board meetings should be changed from monthly to quarterly? 
Clearly, if the Boards are not functional and productive, it can have deep impact on the future of Startups. There is an old Silicon Valley saying that “Good boards don’t create good companies, but a bad board will kill a company every time.”
How to structure an awesome, effective and productive Board?
1. Right People - Choose your bosses wisely
As the CEO, you report to the Board. They assess your performance and decide on key matters of your company. Would you let investors appoint anyone as your boss? You need to "know" the investor representatives who would be appointed on your board even before you sign the term sheet. Spend time with them and if the investor director nominee is not as excited as you about your business, look for replacement. You should also consider diversity of skill sets on the Board. Checking references is also very important. First impressions can deceive. 
2. Size of the Board - Small is beautiful
One of the Board meeting that I attended last month had seven people in the room excluding key management of the Company. Harder to have deeper and meaningful discussions in a larger setting. 
Monthly Board meetings are a time when you get out of your day to day execution mode, take deep breaths and think strategically using directors as your sounding board. The smaller the group, the better the discussion quality. 
Ideal size of the Board at seed stage is three and Series A is five (including founders).
3. Board observers - Try to minimise
Lets be practical, in a meeting, observers don't just observe. They pretty much act as a Board member. They have views, ideas, questions, etc. and it is rude to tell someone that they are there just to observe. Founders should try to minimise the number of observer rights they assign to every investor in the syndicate. 
It does not mean information can not be shared. Board materials, discussion minutes, etc can be shared with everyone who holds a reasonable stake and confidentiality is assured.
4. Chemistry between members - critical
Culture at the Board level is critical. The chemistry and respect among board members for each other defines the overall quality of the meeting and outcomes. This does not mean that all the members have to agree to everything that has been shown or said. Diversity of views should be encouraged. Open and frank conversations are key. Founders have to play a key part in building this culture even at the board level.
One loose canon on the Board can destroy the entire team spirit and that affects functioning of the Board. Founders need to know how to handle critical observations and encourage data backed debates. Stay away from the five types of dysfunctional board members as defined by Jack and Suzy Welch: The Do-Nothing; The White Flag (will do anything to avoid confrontation); The Cabalist (driven by personal agenda); The Meddler (dwells incessantly on details); and The Pontificator (only enjoys hearing himself speak).
5. Advisers are not Directors - understand the difference
Investor Directors are shareholder representatives. They are mostly generalists and rarely specialists. 
If you need specialised advice on something on an ongoing basis, you need to assemble a separate Board of Advisers. However, it is not necessary to have advisers appointed to the Board. 
6. Independent Directors - worth having one
Independent Directors are great to bring balance to a Board. In cases, where there are deadlocks between Founders and Investors at a Board level, an experienced third party can help. 
Very few startups like to get Independent directors involved and most ID seats are generally unfilled. 
7. Frequency of meeting - communication is important

Better Boards meet monthly and communicates more frequently than that. Startups operate in a very dynamic environment where traditional quarterly meetings are useless. 

Besides meeting in person on a monthly basis, real time communication and decision making on key issues is important to build trust and transparency. 

8. Split Board meetings into two sessions and involve key management

In a healthy board-CEO relationship, the board and CEO need quality time together where they can have private discussions.  A customary approach that works well is to divide board meetings into 2 sessions:  First there is an open session, where senior management team members may be invited and they may even be responsible for parts of the agenda. Then there is a private session where everyone except for directors is excused and the agenda shifts to the private Board-CEO discussion and governance matters. 

Friday, April 24, 2015

Alert: Venture Capital Tsunami in South Asia

Last 12 months have been nothing short of a Tsunami for Venture Capital industry in South Asia ( India + ASEAN). Unprecedented capital inflows and interest have completely shaken the local ecosystems. 

Strategic investors such as Softbank, Rakuten, Alibaba, Naspers, etc. are throwing money as if there is no tomorrow. Sovereign Wealth Funds such as GIC, Temasek, QIA and Khazanah want their share of the pie. Even Private Equity firms do not want to be left behind. 

Lets look at some mind numbing data first to feel the intensity of this tsunami:
  • Flipkart raised 3 massive rounds from Series F ($210M), G ($1B), H ($700M) in a 7 month span between May and Dec 2014.
  • Ola raised Series C ($41.5M), D ($210M) and E ($400M) in 10 months between Jul 2014 to Apr 2015.
  • Snapdeal raised more than $727M between May and Oct 2014.
  • Grabtaxi raised 4 rounds of funding from Series A, B ($15M), C ($65M) & D ($250M) in a 9 month period between Apr and Dec 2014.
  • Tokopedia raised $100M in Oct 2014.
  • raised $18M, $19M and $100M between Apr and Nov 2014.
  • PayTM parent One97 raised $635M from Alibaba and SAIF partners in Jan 2015.
Remember Webvan?? Webvan raised Series A ($125M ) and Series B ($275M) from Softbank and Sequoia within a short span between 1998 and 1999. Looks like the same story is being replayed here in South Asia all over again.

I can never comprehend how a startup moves from Series A to Series D in 9 months. Such sudden influx obviously causes ripple effects. Early stage valuations are going through the roof. Series A rounds look like erstwhile Series C rounds. The race is now on to  reach a billion dollar valuation in the shortest amount of time. Hate to say this but to a certain extent these funding rounds now decide who is going to be the winner. Taxiforsure lost its battle against Ola not because their product or team were not great. But because, they did not raise such quantums at the right time. 

Until recently, we never had to worry about a Startup raising too much money. Risk capital was scarce and hence, the default advice was never to worry about dilution, valuation, etc and to raise as much as they can. More money allows for mistakes thereby empowering founders to experiment. A huge funding round also keeps competition at bay. 

However, it is time to be cautious. 

1. Impatient capital will have unrealistic expectations. They would want to achieve leadership position by throwing money to solve the problem. However, if fast growth is achieved only due to capital by providing unsustainable discounting and similar loss leading tactics, then there will be a continuous need for capital. Any reversal in investor sentiment can cause failure.

2. Too much money too soon is fundamentally bad for startups. It forces aggressive execution even for startups who are still discovering their most optimal business models. They just get pressured to enter the rat race. 

3. Growth is not always directly proportional to the money you burn.  

I am not advising against raising big rounds of capital. I am cautioning against over capitalisation. Know how much you need and when ( and also from whom... if you get the choice).

Sunday, February 8, 2015

Venture Debt : Good, bad or ugly?

DBS has just launched Venture debt for tech startups in Singapore. I think this is a first by any Asian Bank and a new product for SE Asia. Silicon Valley Bank (SVB) has been active in India and China but they don't have any presence in SE Asia. Here is the link to DBS' announcement -

Startup community in Singapore has welcomed the move and rightfully so, this opens up options for many startups. However, before jumping on the bandwagon, startups and VCs need to clearly understand its pros and cons. 

The Good : Venture debt
  • Extends the "cash flow runway" for the company and makes it easier to achieve the next valuation milestone
  • Venture lending represents a less dilutive type of financing than venture capital financing since venture lenders generally require less of an ownership position
  • Venture lenders typically take less of an advisory role in its portfolio companies and do not serve on the corporate board of directors
According to SVB website, the best time to raise venture debt is in conjunction with or immediately after raising a round of equity, i.e. when there is the most capital in the company.  It can be done at other times, but often with less favorable terms. Venture lending is appropriate at the following times:
  • As part of a funding round where, for example, rather than raise $10 million in a funding round, a company can raise $7.5 million in equity and $2.5 million via venture debt
  • To extend cash runway when a company knows that it will need to raise another funding round in 12 months, but would like to extend that timeframe to 18-24 months
  • As the last round before an exit instead of, or in addition to, an internal round where taking venture debt will help the investors/promoters receive roughly the same amount with less investment on their part if a venture loan is taken to top up growth capital
  • As working capital in a situation where even though a company has sufficient operating cash, it needs cash for working capital and can extend its resources via a debt facility
  • To finance purchase of equipment or finance office expansions and buildouts, for which equity would be a more expensive alternative
For startups in Singapore, DBS bank has put in these following criteria:
  • Must be strongly backed by DBS’ partner venture capitalists. 
  • Should have raised at least SGD 1 million of Series A funding
  • Be incorporated for at least two years, be in operation for at least one year and have demonstrated that their business model is commercially viable.
In simple words, that means DBS is prepared to come in as early as immediately after Series A round.  They are basically relying on the ability of their partner VCs to assess the startups that are commercially viable. Startups that have the confidence to reach inflection points can make good use of this Venture debt. Leverage can amplify the returns for all shareholders.

So what is NOT so good about this Venture debt?

1. Accepting Venture debt too early

Accepting venture debt too early in the life of a Startup is risky. Leverage is a double edged sword. It good times it can improve returns for all but in bad times it can cause more harm. In case the Startup fails to reach its inflection point, it might become nearly impossible for the debt loaded Startup to raise follow on funding from other investors or pivot. It is best when debt is used to fund organic and inorganic growth at later stages. 
2. Covenants and other default clauses

It is also important to learn how DBS writes its loan covenants. In case, the business growth is not as expected, the bank might recall its cash when the startup needs it the most. It is hard for banks to behave like VCs. “Material adverse change” and other “subjective default clauses” can allow a lender to recall their loan due to events beyond the company’s control (e.g., an existing equity investor deciding not to participate in a future round).

3. Using venture debt financing as a last resort

Venture debt doesn't suit a company which is unable to raise follow on equity financing and expected to run low on cash. This would over burden a non performer and eventually make it harder to turn around. 

To conclude: We would have to wait and see the details of terms and conditions DBS is going to propose. Assuming that they are at par with SVB, venture debt is a strong option for venture-backed companies who want to add capital and minimize dilution. Though more expensive than traditional working capital lines, venture debt offers far greater flexibility. However, excessive debt or loans with heavy restrictions can be detrimental to a business, and the terms of any potential financing should be considered carefully.

Monday, November 17, 2014

Can Singapore produce Billion dollar tech startups?

Singapore's tech ecosystem has remarkably improved from what it was five years back. From an occasional early double digit million exits, we have now seen many companies hitting the Centurion (100 million) mark. But has it improved enough to produce Unicorns ( 1 billion) ? Does the ecosystem have capabilities to produce the next billion dollar tech startup?

Lets do a deep dive and assess the elements that are necessary for that to happen.

1. Quantity : Number of startup formation had reached healthy levels in 2012-2013. In 2009, we used to receive two pitches per WEEK. Contrast that with 2013-14 average of two pitches per DAY.
We all know that this did not happen organically. Government has done a lot to prime the pump. In my mind, the biggest contributor to this ecosystem was the TIS scheme launched by National Research Foundation (NRF). This was not a perfect scheme. But it gave Singapore the right to call itself the regional hub for tech companies. It attracted talent from all over South East Asia. Sadly, NRF has shifted its focus from what they consider "Low tech" to "High tech". I personally don't think that iJAM reload can completely fill the gap. But that is making iJAM program really competitive. I was on an i-JAM panel recently and to my surprise the quality of startups was at par with some of the TIS companies. IDA is getting active by approving a number of new incubators to seed many more as well. However, Spring Singapore seems to have taken a back seat. Time will tell if the ecosystem can adapt to these governmental decisions but the activity levels as of now are healthy.

2. Quality:  Over time the quality has become better as well. The teams are well rounded and have more experienced founders. But do we have the quality of producing Unicorns? I personally don't think that we are short of skills here. We have lot of founders who are great starters who can take the companies to Series A. We also have talented experienced hires available in regional head quarters of various tech companies who can scale the potential winners. However, we need smart capital that can make this transition successful. I personally know that some very smart people are raising Series A funds and are in various stages of closing those funds. The challenge for all these funds would be to come in early (earlier than a typical Series A) and fill the void created by NRF. Will they? I don't know. May be that will force the founders to be more creative on how they syndicate and/or Bootstrap.

3. Support systems:  We now have a reasonably healthy mix of incubators, co-working spaces, growth funds and corporate participants. However, we are short on two things: good seed stage funds (accelerators) and regulation.
Seed stage shortage can not be addressed by Angels. We desperately need smart seed stage investors who practice emergent strategy and can help transform ideas into scalable businesses. This will build the pipeline for Series A funds about to be raised. This is the single biggest problem with our ecosystem. Series A gap is being filled at the expense of Seed Stage capital. Most active seed investors are now becoming Series A investors. In absence of good acceleration funds, they all might have to retune their expectations.
Regulators are also not in sync with what is expected from the "easiest place to do business". I have had some experience dealing with Monetary Authority of Singapore (MAS). And they are no where near UK Financial Conducts Authority (FCA). If we want to play to our strengths, we can't ignore Fintech. And, we can't focus on Fintech without a proactive MAS. Hope someone is listening.

To conclude, IMHO, Singapore can produce billion dollar startups provided it plays to its strengths. Enterprise Software and Fintech are two areas that we can easily build without going anywhere. And, regional consumer startups are also a huge opportunity if we move out of our comfort zones and explore Southeast Asia.

What do you think? Constructive criticism is very welcome.. 

Monday, July 14, 2014

Alibaba's investment in Singpost and its implications for Startups and SMEs

Alibaba recently took a significant minority stake in Singpost for S$ 312.5 million ( US$ 249m). This was announced right after its US$ 206 million investment in Shoprunner Inc. and participation in US$ 250 million Series D in Lyft. These transactions made it amply clear that Alibaba wants to complete the loop by inorganically playing the last mile delivery scene. But why this interest in last mile delivery from a successful enterprise commerce platform?

Alibaba clearly has the global sourcing under its control. It would be hard to find a decent supplier or manufacturer in China (and beyond) who is not a verified (paying) member on its website. It dominates the Business to Business commerce. But whats next?

Their ambition now is not just to supply to distributors, traders, brands, and other intermediaries. They want to connect the producer to consumer. No intermediaries. It seems that now they have set their sights on Business to Consumer commerce. As a result, its business model is rapidly evolving from "Factory to Port" to "Factory to Door". And it is the last bit of "Port to Door" that Alibaba is now trying to sort out.

Imagine a world where an individual in Ulaan Bataar ( do you know where it is?) can use their phone to logon to Aliexpress, select anything that can be manufactured, verify the manufacturer, make payment and get it delivered the same/next day at its doorstep. This completely removes middlemen and the 7 time price hike from FOB price to MRP.

What does it mean for SMEs who are just intermediaries?
Death. Yes. All those businesses that thrive on being an intermediary and making money on inefficiencies and opaqueness of the market will eventually become irrelevant. Good luck to private equity players who are busy doing deals in "mature" intermediaries.

So where is the opportunity and what does this mean for Startups?
It is really important for all e-commerce related startups to think beyond just creating a shop front and throwing money on google adwords. Can they build a sustainable business model? What would be their edge when a common man can buy anything direct from the factory floor. Can they be part of the future value chain? Lots to think.. and act :)

Note: We have invested in that provides logistics and fulfillment services to businesses and brands in SE Asia and are looking for more opportunities to invest and build the businesses of future.

Monday, February 10, 2014

6 CEO types to avoid

I felt like I have mined a bitcoin when i recently came across this interview with Tom LeFevre, co-founder of Intuit on assessing startup CEOs. Link here for detailed interview:

He highlighted six types of CEOs to avoid while investing - Functional Vice-presidents, Researchers, Inventors, Fund-raisers, Small businessperson, and Corporate Executives.

The first three types he called "not" CEOs because they lack general management skills. The remaining three types he called "flawed" CEOs.

1. Functional VPs: who were successful but never made the transition to CEO. When these CEOs encounter a business problem, they try to solve it using their functional skills. As an example, a CEO who had been a vice-president of sales in his past life, approached every problem by trying to get more sales. His company's problem was in operations. Sales volume was already more than the systems could handle, so more sales orders just made the problem worse. But this CEO couldn't make the transition from functional expert to general manager.

2. Researchers : Their passion is investigating the technology. The product never gets finished because there is always some issue they want to go explore. They spend their time and resources on that instead of commercializing.

3. Inventors : They like to invent things and may even come up with products, but they have no interest in commercialization.

4. Fund-Raisers: These people are really good at raising money for their company, but they aren't very good at running the business. They don't understand the customers. Products don't get done; revenue progress is weak.
The CEO is so good at selling the potential. There hasn't been a down round, but we're unlikely to ever see returns.

5. Small Businesspeople: These people have the CEO title and they sort of function as CEOs, but they don't really do the job. Either they lack focus, have low potential, or they can't scale. These CEOs can manage a seed stage startup with eight or ten people in one location but are over their heads once the company starts to gain traction and grow.

6. Corporate Executives: They typically don't understand the importance of cash in a start up and require high overhead to function. The company will end up with four "C" level executives, three vice-presidents, and twenty-eight managers in a low margin hundred-and-twenty-person company.

Tuesday, December 3, 2013

VCs : Adapt or get disrupted

Venture Capital industry makes its livelihood by investing in disruptors but the functioning of VCs have not changed much in decades. However, this is all about to change very soon.

Angel List is changing the way seed/early stage syndicates are formed. Google Ventures is changing the way Startups are spotted. 500 Startups is delocalising the industry. Corporate Venture arms are investing as early as Series A. Here are the 6 ways VCs need to adapt before its too late:

1. General Partner (GP) composition 
General Partners (GPs) have so far survived on being good generalists. But, entrepreneurs are getting more savvy. They are becoming more demanding. They are not just looking for money. They are looking for money + a platform, a network and a partner who can do business development for them. VC firms who invest in supplementing GPs with operating partners (for specialist assistance in growth hacking, hiring, business development, M&A, etc.) and in some cases, venture partners (for domain expertise) would attract more savvy founders. Obviously, this would mean a smaller pie of management fees but hopefully, a larger pie of carried interest based on better performance.

2. Delocalisation
Gone are days when aspiring entrepreneurs have to line up within 30 minutes driving distance of VC offices in Silicon Valley. New hot spots of innovation are emerging. With improvements in connectivity, it has become much easier to build a billion dollar Start-up (in some sectors) from Bangalore, Shanghai, Jakarta or Singapore. And, money follows opportunities. Sequoia is present in the US, India, China and Israel. Accel is present in the US, UK, India and China. And, they are not just investing in the countries they are present in but they are also syndicating with smaller funds around those regions. Some VCs might retain the criteria of investing locally within a certain travelling distance and end up having many more satelite offices as a result of that.

3. Data driven investing
This might sound a bit too geeky but it has been established that successful start-ups can be spotted better by applying data analytics techniques. Google Ventures claim to use some of those techniques. Firms like Angel List would have lot of clever data to predict the home runs of future. Savvy investors have successfully used algorithmic trading for gaining that unfair edge.

4. Increased spend (time and money) on Self branding and outreach 
Traditionally VCs have limited themselves to PR and marketing only when they invest in a Start-up or have had a successful exit. But things are changing for the good. They are now churning out blog posts, tweets, interviews, speeches, etc. Some are leading by making the ecosystem more transparent and providing thought leadership while others are quietly building sector and domain expertise. Some are even raking up air miles to speak at every possible opportunity anywhere in the world. 

5. Multiple stage funds 
Stage focus is going away. Investing in either seed or growth stage alone will be difficult. Micro VCs would find it difficult to survive because when Start-ups have a choice of raising money from someone who could do follow on funding versus someone who can't, they would choose the former. Also, growth stage VCs will find it hard to source deals. 

6. Syndication with Corporate Venture Capital firms
Corporate VCs are generally ignored because nobody likes Strategic investors at the early stages of a company. But I think they will become a much stronger force in the future. They are getting more aggressive and are even willing to invest at the seed stages.

What do you think? Anything you would like to add to the list?

Saturday, June 15, 2013

Bet on the Horse or the Jockey?

Besides the usual screening process, every investor I have met so far, also has an unwritten methodology known as the "gut feel". It is difficult to admit but investing is as much an Art as it is a science. Partners of the same firm who would follow the same technicals sometimes differ from each other when taking an investment decision.

What exactly is that gut feel? I think it is the Big Data analytics derived by the super computer in our head by scouring through years of varying experiences. I was looking back at my experiences and how my gut feel has evolved over the years. Do I tend to invest in a good idea or a good founder? Essentially the age old question that every investor has in mind - Bet on the horse (idea) or the Jockey (Founder)?

Before I formally started my investing stint, I used to think that a good idea is everything. All you need is that one bright spark...and thats it. I used to take execution for granted. My belief was that if you believe in your idea and are investing your blood and sweat into it then it should have a high probability of success. But when I saw some really passionate and dedicated guys making deadly mistakes, I realised the importance of founder's capability of being a real chief "Executing" officer.

Naturally, I started giving lot of importance to the Jockey. But then, as luck would have it, I met a lot of capable founders solving the wrong problems. Either the idea they were working on was too early or too late. Investors who believe in the Jockey often argue that a smart founder would timely pivot and steer the company in the right direction. Easier said than done. You never know how many pivots are needed before the original idea transforms into a successful investment. And also, there is a new fashion of failing fast. If something is not working out, chuck it. Investors already know that not all of their investments are going to succeed.

But is this really a either/or question? or is this a neither/nor question?

Practically you can never find out whether the founder is good or not until you spend time with them. Needless to say that finding a good idea is exactly equally difficult. So does it mean investors can neither bet on the Jockey nor the Horse? Then what ...... Spray and pray (like most Angel investors)/ Lean VC (Poker) style like Dave McClure - Bet a little, assess and then raise your bet. How should professional VCs invest? I looked at some big name VCs in the valley.

One thing was common: They all start top down. They identify industry trends, zoom into the sectors that makes sense to them and then pick the founder and idea. KPCB is investing in Mobility heavily. Sequoia is looking for SaaS deals. Accel launched a 100 million big data fund in 2011.

Is it time we start looking around the region, figure out what CWCs (Companies-with-cash ) are/would be looking for and fund those sectors? May be its time to bet on the right race (and not just on the Jockey or the Horse)...

What do you think? Do we have enough deal flow in the region to do that? I will let you know if I change my mind again ;)

Friday, February 15, 2013

How to perform Due Diligence on a tech startup?

Asian tech startup ecosystem is itself in its early stage. And as a result, we do not have enough investment and compliance professionals who are familiar with the most appropriate and efficient Due Diligence process. Venture Capitalists and Angels end up ignoring certain areas due to lack of specific knowledge (particularly Corporate laws) while Compliance professionals from CPA firms end up overdoing certain checks because they look at startups from listed company point of view. I recently came across a startup that was reviewed by a BIG4 accounting firm in a way they would audit a listed utility company. Felt like someone is cutting tomatoes with a sword.

In my view, Due Diligence effort is most productive when it is tailored to the stage of investment.

Seed Stage Due Diligence

This is most relevant for Angels and/or Early stage VCs. At this stage, the company would at most be a few founders and a prototype. The most important things for an investor at this stage to do are as follows:
  1.  Jobs to be done (JTBD): Is there a real market need? Speak to potential customers.
  2. Team capability: Does the team have necessary skill sets to execute and the temperament to sail through the ups and downs? Meet up with Team members individually and do reference checks on key founders.
  3. Competitive landscape: Prepare a summary of local and global players in the same/similar area and collect as much information as possible.
  4.  Exit potential: Prepare a list of potential acquirers and document why they would acquire a company like this.
  5. Founder’s pre-nuptial: Ask founders to document the terms of their co-working arrangements. Verbal agreements or inappropriate drafting of these arrangements can cause lot of disturbance for the company. If possible, also need to get founders to sign a non-disclosure and non-compete in case of a break-up.
  6. Employee contracts: Ask for employment, non disclosure and non-compete agreements duly signed by all part-time as well as full time employees. If there are non-local employees, look out for their legal employment status. 
  7. Pre-existing liabilities: Ask founders to disclose all pre-existing liabilities including options granted and/or notes issued to third parties. Get them to sign an undertaking.
  8.  Licensing agreements: If the entire technology of a part of that technology is licensed from an external party, the terms and conditions of usage of technology should be properly documented.
  9. Record keeping: Select some transactions from the financials (if any available) and look for supporting documents.
  10. Co-investors: Meet up and get comfortable with key co-investors particularly those who are close to founders.

Growth Stage Due Diligence

This is a stage when there is lesser ambiguity than seed stage. The company would likely have more data points and records to ensure a more detailed Due Diligence. This is a stage where involving a CPA and a lawyer makes sense. But it is still not possible to outsource all of the required Due Diligence. Partly because the professionals here are not very familiar with technology startups and partly because there are areas that CPAs and/or Lawyers would have no clue. 

In my view, at this stage, the most important items to watch for are:

Value Proposition:
  1. Look out for the "unfair advantage" and verify that by speaking to at least one or two industry professionals. It can be the technology, business model or a combination of both.
  2. Obtain a competitor landscape from the founders and verify that independently. Big red flag if founders have missed out on some prominent ones. 
  3. Get details of Strategic alliances, Joint Ventures or other partnerships. Check if any of that might become a roadblock in future exit plans. 
  4. If the company has multiple products, obtain features and pricing details for the entire product range.
  5. Request for details of "Use of capital " and ensure that it makes overall sense. 
Investment history
  1. Obtain a Capital structure table (Captable) and verify that with data independently obtained from government agencies (like ACRA in Singapore or ROC extracts in India) or independent data providers. Ensure all convertible notes, stock options, warrants, etc. are fully disclosed to calculate fully diluted outstanding shareholding pattern of the company.
  2. Ask for a copy of previous Shareholders and Subscription agreements. Go through previous investors rights/options to participate in the current round.
  3. Meet up with at least all the investor representatives on the board of directors. It is important to establish that the future board is going to be functional.
Legal and Secretarial
  1. Get a copy of Memorandum and Articles of association to ensure that they are upto date and reflect all the changes made during the previous investment rounds. 
  2. Obtain minutes of all previous board and shareholders meetings.
  3. Ask founders to provide details of all existing/previous/threatened legal disputes, litigation, arbitration or judgement/s. A declaration/undertaking from the founders that information provided is complete to the best of their knowledge is also desirable.
  4. Ask for details of all Patent, trademark, copyright applications (in-progress and/or granted).
  5. Go through all licensing  and other agreements. 
Financial performance and projections
  1. Get a copy of latest board approved budget, management accounts and audited financials (if available). Compare revenue and expenses between budget and actual accounts to identify and explore deviations. This can also be used to analyse future projections.
  2. Review gross margins and net margins for each product line and assess if direct expenses have been pushed below the line as overheads. 
  3. Analyse working capital items (debtors, creditors and inventory). Ageing list can be very helpful. 
  4. Ensure that amounts due to technology and other service providers are accrued and recorded in accordance with agreements as liability even though they are not paid out. 
  5. Obtain details of bank mandates and signatory limits.
  6. Obtain copy of bank statements for all the accounts held in company's name. Match bank balances with the latest audited/unaudited financials provided.
  7. Ensure that the company has filed all its tax and annual returns with relevant authorities. Get copies of tax assessment notices. 
  8. Carefully look for related party transactions and ensure that they were conducted at arms length. 
  9. Go through the list of fixed assets and verify material items. If there are huge intangible assets capitalised in the balance sheet, make sure that they are valued realistically.
Human Resources
  1. Get a copy of company's organisational chart and list of employees with their roles. 
  2. Verify employment contracts, non-disclosure and non-compete agreements (where applicable).
  3. Look for historical attrition rates to identify unusually high staff turnover.
  4. Ensure that all the employees have the right to work in the country they are based in. Also, verify that the company has been promptly paying the employer's contributions in accordance with local laws. 
Technical (Depends a lot on the sector whether it is software, hardware, biotech, cleantech, etc. but there are some common themes)
  1. Capability of the technology: To ensure it does what it promises, schedule a demo. Prepare a walk through of various use cases. For software, go through the functionality from both front and admin ends and document screen shots. For biotech, look for data coming out of independent trials. 
  2. Stability and scalability: This is relevant primarily for software startups where architecture, algorithms and databases need to be assessed for stability and scalability. Obtain a list of infrastructure monitoring tools used by the company. Get a description of redundancies built into the hosting platform and hardware.
  3. Usage data: Obtain monthly traffic reports like site visitors, unique visitors, registered users, returning users, etc.
  4. Third party tools: Obtain a list of third party tools and/or content utilised by or embedded within company's products. Ensure that licenses are in place. 
  5. Development roadmap: Review company's plans and "Use of capital sheet" to assess if significant pivot in product direction are anticipated in coming years. 
  6. Ownership: Evaluate academic affiliations of Founder/s and/or CTO to assess competing claims on the technology. If the technology is licensed from a research institute, assess the impact in an exit scenario. 
Hope this is useful not just to investors in their assessment but also to founders in preparing well in advance for a smooth and efficient due diligence. Do please let me know if I have missed out on any other important item.