How to Read a Pitch Deck. Due diligence
How to Read a Pitch Deck. Due diligence
One of the key steps in investments to protect your money from dubious deals
Due diligence is the process of a comprehensive company analysis: from specific documents, papers, facts, and other formalities to hypotheses, business models, technologies, and the founder's personality. It is necessary to verify the authenticity of the startup.
The better we look into the company, the less likely we are to be faced with unpleasant surprises in the future. If the pitch deck is the wrapper, then due diligence checks the substance of everything in it. The term due diligence itself applies to any business, not just technology companies, i.e., startups.
Even if you are new to investing and have rarely heard the term, rest assured that you have probably been involved in some form of due diligence. Even if it's in a limited way.
I would like to thank Elya Checheneva, principal of TA Ventures, and Sofia Brutsyak, ICLUB lawyer, for their assistance in preparing this article.
The Long Road
Every startup is bound to undergo due diligence, regardless of its stage, industry, previous investment experience, etc. Moreover, even if there are several funds involved, each one does its own due diligence without looking at its neighbors. There is an assumption that only the lead investor performs due diligence, but this is not true. Different parties to the deal can ask, check and look for certain nuances. Due diligence takes at least two to three weeks and depends on a number of factors, such as the stage of the startup. In general, the older the company, the more time is needed.
That's an interesting question: Is due diligence really necessary? Do startups hide or cheat everywhere? As a rule, no. At least not in our experience. Most of the problematic areas can still be seen on the surface. However, there is always the possibility of catching a nugget that looks like the iceberg of a meme: simple on the outside, but when you dive in, you can't see it right away.
In 2022, that nugget was the scandalous medical startup Theranos, which raised $900 million from 275 investors (!), none of whom saw the fraud. Of course, this is the exception rather than the rule. In everyday life, investors face more prosaic situations. The founder may omit the ultimate beneficiaries who do not inspire confidence. Or exaggerate the financials, miscalculate the market, and forget to file documents for the regulators. All in all, we have a lot to work with.
Investment and Legal Decisions
In our practice, we divide all startup due diligence into two notional groups: investment and legal.
The investment part always precedes the legal one. First, we decide on the investment as such and only then do we ask for sensitive documents. You may already know, or at least have heard, about the matters we are investigating here. These are the team, the product, the business model, the technology, the market, the benefits, etc. In other words, all the stuff that the pitch decks, to which we have devoted two major pieces of material here and here, tell you about. Knowing how to read pitch decks means that you have already done part of the due diligence.
Another notable feature of the investment part of due diligence is that it touches on subjective parameters. For example, the quality of management, the portrait of the founder, and the mood within the team. Such subjective metrics are not as much nonsense as they may seem. Investopedia, citing the Harvard Business Review, reports that 70-90% of unsuccessful M&A deals are due to ignoring the human factor (which we also have an article on).
As you can see, each of you can help with due diligence if you have delved into the startup enough to uncover details worthy of attention, if not alarm.
The intensive due diligence process begins in the legal group, where we check all the documents and other data with specific numbers and names. This is where specialized professionals such as lawyers and financiers come in. Each is given the part of the startup where he or she has the appropriate skills.
The good news is that, in all probability, our readers will not have to take part in this process. It is confidential and requires special training in a wide range of disciplines, from matching passports and patents to country-specific regulatory policies and property rights. We will just look at the most common things that need to be verified and break them down into logical blocks.
What exactly do we need for a Legal Decision?
Let's start with a note. Different funds may require different amounts of documentation from startups. Below is a basic list used by TA Ventures for early-stage companies.
The funds strive to optimize the documentation package so as not to overburden themselves or the startup team. In fact, we have no desire or reason to review every single piece of paper. Investors are looking for a balance, to get as much information as they really require, not just free stuff.
Basic corporate documents. Also documents for AML-KYC procedures
These include a company's articles of association, a certificate of formation, a current extract from the commercial register, and a full corporate ownership structure. The latter discloses all shareholders and ultimate beneficial owners (UBOs) of the company. In addition, we are also interested in ID copies of UBOs who hold substantial stakes in the company (usually more than 25%). The list is rounded off by permits/licenses to start and run a business (if such are necessary).
We scrutinize the UBOs to ensure that there are no business relationships with individuals associated with terrorism, corruption, or money laundering, among other things. We also require AML/KYC policies for startups where appropriate.
Other corporate documents
Warrants, options, convertible securities, and other instruments, such as SAFEs, that may result in dilution later on. Planned issuance of shares, such as employee stock options. Agreements between a company and any of its shareholders and/or a director (CEO).
Basic finances
Financial statements for a given year (or years), balance sheet information, and financial obligations and debts of any kind.
Material agreements
Substantial agreements of a certain value (e.g., over $20,000). Real estate agreements. Customer and partner agreements, including terms and conditions. Any other agreements that are crucial to the business.
Intellectual property
A list of all copyrights, patents, domain names, and trademarks. A list of the major components used to create the company's product (including open source, licensed software, and APIs). IP and software license agreements. A description of any IP or software litigation. A description of privacy standards and policies.
Human resources
List of all employees, consultants, and freelancers. Employment contracts of key employees. Employee benefit plans, including stock option plans. Details of any insurance plans for employees established or maintained by the company.
Court proceedings or disputes
Tax debts or any disputes, legal, administrative, or regulatory proceedings.
Others
Insurance programs that cover the company's liabilities. Received government grants. Finally, any information about known or possible events that could have a negative or substantial impact on the company.
From the Editor
As you can see, there is plenty of room for rough edges and clashes, which makes the investment process complicated. It is easy to fall in love with a startup. The trick is to make sure that love passes the sacred due diligence test.
And while we're on the subject of startups that have stood the ground. Our portfolio company Impress announced the acquisition of London-based orthodontic brand Diamond Whites, creating the largest chain of orthodontic clinics in the UK. Congratulations to the team! Read more here.
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