A crisis also brings opportunities. Changes unfolding in the global economic landscape with COVID-19 have leaders re-evaluating growth strategies and business models, all conventional ways to work have been put through the grinder; we’re seeing the emergence of a new normal.
The financial sector has stumbled upon a hitch, as fund managers find it difficult to raise money for a first or final fund close. For those with dry powder, the challenge to wisely allocate funds, appoint a new team or go with an existing team is seen rising.
Investors across the globe share the belief that due diligence (DD) forms the most critical component of an investment process. Agnostic of the type of financial organisation– VC or PE fund managers, family offices or institutional ones, DD is a key process followed before investing in a fund or company.
The process of DD has multiple facets such as investment strategy, target markets, financial, legal, business, reference checks and more. Pre-pandemic, the process demanded on-premise and in-person engagements, which could go on for weeks, if not months. For example, an investment in a manufacturing company involved physical meetings at the production facility.
In sustainable agricultural technology investments it was standard DD to meet the different value chains and local producers, to review utilisation of the technology in real-time. These meetings were followed by interviews and more meetings with the staff and other investors, checking internal systems, processes and technologies.
Why? The findings and impressions gained during the DD stage can make or break a deal and can be the difference between investors making money or losing everything.
Also Read: Due diligence meets imagination: How SGInnovate plans to further support the deep tech ecosystem
Changing the course
Cut to the pandemic era, financial organisations now have to adapt to the new rules of due diligence. Futuristic investors and fund managers see an opportunity in revitalising investment due-diligence processes and infusing technology to weed out the inefficiencies. Communication tools such as Zoom, Microsoft Teams, Google Meet, and others are already par for the course; they were here before the pandemic and certainly will outlast the pandemic.
Platforms such as Dropbox and Google Drive find more user reliability instead of tracking documents on emails. These widely used tools help create easily accessed cloud content, collaborate remotely and share heavy files, enabling the due diligence team to gather information and insights fast, easy and effectively.
In addition, improvements in data management, records digitisation and videoconferencing technology, help one to carry out effective due diligence reviews virtually. This has worked well for VC funds who have seen increased interest from institutional investors, and who want to show that they can continue to invest capital in promising companies in a pandemic world.
A study by Omers Ventures of 150 VCs across the US, Canada, the UK and the rest of Europe shows that just four per cent of VCs are opposed to undertaking remote deals. Among the 96 per cent of VCs open to it, 42 per cent said they are willing to make changes to their processes to enable this. Interestingly, 40 per cent of the VCs surveyed said they had already done a fully remote deal, while 60 per cent are yet to do so.
With the practice of virtual DD, physical engagement can be kept to a minimum or eliminated entirely or undertaken only if absolutely required.
How to go about normalising remote due diligence
There is no one shoe fits all practice to take this forward. VC funds address virtual DD in multiple ways as they focus on closing their pipeline of deals. In instances, relationships have been established with founders through meetings and conversations that have been going on for months, much before COVID-19 struck, and term sheets have already been signed. Closure of these deals has been relatively easy, as evidenced by the continued global flow of VC capital in Q2.
Also Read: Due diligence meets imagination: How SGInnovate plans to further support the deep tech ecosystem
With others, initial conversations have been fruitful, but final DD and signatures are pending. VCs are actively leveraging partners in the areas where these potential investees operate to drive some level of due diligence. Backchannels and talking to third parties were always an important driver for insights and this has further increased.
Further what simplifies the DD process is connecting with previous investors or funds who have already entered in the investment. Some VCs and other investment firms have, during the pandemic, done approximately 30 per cent of their due diligence remotely. Virtual tours have helped provide facility tours.
The quantum of discussions with founders has increased both at the individual level and in groups. Founders are also being encouraged more to connect across the network — with funds, entrepreneurs, and accelerators — in their local region. Remote DD has shown the critical role technology plays now when making an investment decision. References and testimonials apart, technology is the main driver of remote due diligence processes today. And from the looks of it, will continue to be so going forward.
Just Zoom meetings are insufficient to entirely conduct DD when mobility is hampered. Potential investees are working hard to help potential investors find ways to visit their factories, offices or warehouses and see first-hand what’s happening, how employees are engaged, how much stock they have and gather other information that will help the deal move forward.
Dependency on co-investors too has increased. Founders are under even more pressure to come with strong references. The increased emphasis on client checks is encouraging portfolio firms to try out the products or services of the companies under due diligence.
Be wary of betting on the wrong horse
DD is a multi-fold process and may not be always contained within set timelines. The current situation may lure investors to make mistakes. Lack of performance can be disguised under the pandemic, and going just for the supposedly “winner” sectors during COVID-19 may result in an expensive and simplistic approach, where you bet on the wrong horse.
Also Read: The hidden side of fundraising: how due diligence can make or break your deal
The fact that you’re conducting remote due diligence should not relax the depth of the analyses. If anything, there are now new scenarios to play with, new indicators to look at, to see if we’re in front of attractive investments or not. The good news? It all can be done remotely.
Business continuity is the ultimate goal
In the current situation, where travel is significantly restricted, if not impossible, not institutionalising remote due diligence will limit business progress. Of course, having a large, well-dispersed team with deep industry relationships can be an invaluable advantage in the current environment. Nimbler investors who can harness the power of technology and couple that with a well-tentacled network may be at a significant advantage as they will draw on local capabilities to maintain due diligence processes and capture new opportunities.
Investors unable to draw on such resources will need to outsource parts of their process to trusted third-party specialists. The pandemic and the challenge that it imposes on due diligence should therefore not be an excuse to let the baton slip. It should be the catalyst that enhances scrutiny by utilising technology to further augment existing processes.
Undoubtedly, the process now takes longer; it involves far more scrutiny. A simple thing that spoke volumes during normal times, which VCs now miss, is picking up on nonverbal cues when interacting with people or teams in person. Zoom calls cannot compensate for this. A few investors will, nevertheless, prefer waiting it out till the pandemic is over.
That may just turn out to be a long wait. And there are too many challenges in the world waiting to be solved through companies using innovative technology. The investing world cannot grind to a halt.
–
Editor’s note: e27 aims to foster thought leadership by publishing contributions from the community. Become a thought leader in the community and share your opinions or ideas and earn a byline by submitting a post.
Join our e27 Telegram group, or like the e27 Facebook page
Image credit: Loverna Journey on Unsplash
The post How investors are adapting to effective due diligence practices in the new normal appeared first on e27.