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Redesigning Investment Due Diligence in a post-COVID World

“When written in Chinese, the word crisis is composed of two characters. One represents danger and the other represents opportunity.” It is a famous quote attributed to John F. Kennedy. Undeniably, crises present opportunities; we’re seeing one unravel across the global economic landscape with COVID-19.

From factories reimagining global supply chains to tech companies – fintech to MedTech — reevaluating growth strategies — all conventions are going through the grind and emerging with a new normal. Same with the financial services sector.

Fund managers are finding it tough to keep the capital flowing; yet many intrepid investors, investment managers and operational due diligence teams are seeing an opportunity in revitalizing investment due-diligence processes and infusing technology to weed out the inefficiencies. One such new approach has enabled the virtualization of due diligence.

Any investor will testify, due diligence is a critical component of an investment process. Investors (VCs, PEs and others) do elaborate due diligence on the company they plan to invest in. This has multiple facets — financial, legal, business, markets, and more.

The process is then farmed out to specialist firms (often legal entities) and involves exhaustive in-premise and in person engagements which go on for weeks, if not months. For example, an investment in a product company will involve meetings at the production facility, ag-tech investments will see visits to farms and so on.

These will be followed by interviews and meetings with the staff, analysis of confidential documents (usually done on-site), checking of internal systems and processes and evidencing systems and technologies. Due diligence is literally the final step in the investment process; its findings and/or impressions gained can make or break a deal.

The good news is, following improvements in data management, records digitization and videoconferencing technology, one can carry out effective due diligence reviews virtually. Physical engagement can be kept to a minimum and undertaken on a ‘need-to’, not otherwise.

This has worked well for VCs who see increased interest from institutional investors, general partners (GPs) and their respective investment managers to take advantage of low valuations and invest ready capital.

A study by Omers Ventures of 150 VCs across the US, Canada, the UK and the rest of Europe (data sourced from the video of the virtual meeting shared by Unitus) shows that just 4% of VCs are opposed to undertaking remote deals.

Among the 96% of VC open to it, 42% said they are willing to make changes to their processes to enable this. Interestingly, 40% of the VCs surveyed said they had already done a fully remote deal, while 60% are yet to do so.

A new normal for remote due diligence

What emerges from conversations with VCs and clients is that there is a push for remote, or virtual due diligence. However, there is no real, defined system to take this forward. Consequently, we’re seeing VC firms address this in multiple ways as they focus on building a pipeline of deals.

In some cases, relationships have been established with founders through meetings and conversations that have been on for months, much before COVID-19 struck, and term-sheets have already been signed. Closure of these deals has been easy.

With others, initial conversations have been fruitful, but signatures are pending. VCs are 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; this has now increased.

There may have been investors before, so connecting with them is also useful and helps the due diligence process. Some VCs and investment firms have, during this time, done approximately 30% 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 the region.

This helps the due diligence team to gather information and pick up insights easily and more efficiently. Relying on co-investors too has increased. Founders are under more pressure to come with strong references and testimonials than before.

The emphasis on client checks is far more and existing portfolio firms are being encouraged to try out the products or services of the companies under due diligence. Undoubtedly, the process now takes longer; it involves far more scrutiny – all of which takes time.

A simple thing that spoke volumes during normal times, which VCs now miss is picking up on non-verbal 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. Personally speaking, that may just turn out to be a long wait.

The elephant in the room

The current situation may lure investors to make mistakes. These conditions could cause investors to believe that they must take unnecessary risks and perhaps accept conditions or terms that they would normally avoid.

Remote due diligence helps address that problem and that is where technology plays a critical role. 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.

Communication platforms such as Zoom, and others are already parfor-the-course; I suspect it could well outlast the pandemic. But Zoom meetings are not enough to conduct due diligence in its entirety 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.

So, virtual tours using on person cameras to get the so-called lay of the land are now an important addition to the remote due diligence arsenal. Teams are relying on platforms such as DropBox even more, instead of tracking documents on emails. These collaborative tools are also helping create cloud content, collaborate remotely and share heavy files.

The end-word is business continuity

In the current situation, where travel is significantly restricted, not institutionalizing remote due diligence can be limiting and affect business continuity. Of course, having a large, well dispersed team with deep industry relationships can be an invaluable advantage in the current environment.

In such a situation, however, 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 ride 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 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 utilizing technology to further augment existing processes.


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