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Investors looking to put money into new business ventures undertake a process known as due diligence. So do companies looking to acquire or merge with other companies. The due diligence process culminates in a series of reports that investors and management teams use to determine how to move forward. Valuation reports are chief among them.
Here’s the dirty little secret about valuation reports: they are not the sum total of due diligence. They are not the be-all and end-all. Any investor who decides to invest in a startup based solely on a valuation report is taking a huge risk. Likewise, the attractiveness of acquiring an existing company goes well beyond its value.
Experienced investors and management teams know that there are plenty of intangibles that don’t show up on valuation reports. Furthermore, Utah-based Mezy says that a comprehensive due diligence analysis includes those intangibles. You cannot overlook them and still make an informed decision.
Intangibles Make Up the Majority
Comprehensive due diligence looks at literally dozens of aspects of a business’s operations. Though there are exceptions to the rule, it is generally agreed that the legal and financial aspects only make up about 20%. The remaining 80% pertains to the intangibles.
What are those intangibles? It would be impossible to discuss them all given the differences between industries, but here are the most common:
• Business model
• Day-to-day practices
• Customer relationships
• Vendor relationships
• Competitive edge
• Workforce size, skills, and talent.
Analyzing these tangibles means looking beyond bottom-line numbers. It means looking into all of the individual mechanisms that make the company work. Mezy likens it to clock works. Inside an old grandfather clock are plenty of gears, pins, springs, and so forth. They are all integral to the clock’s function. Before buying an antique clock, you would want those individual components thoroughly inspected.
Some Are Better Than Others
The need to analyze intangibles strongly indicates that due diligence needs to be performed by experienced professionals. In Mezy’s case, they offered diligence-as-a-service (DaaS). Other companies offer the same services but, as in any industry, some are better than others.
A service provider whose main focus is the evaluation report may be very good at that aspect of due diligence. But how does it handle the intangibles? Does the service provider have a track record of compiling the right data, analyzing it correctly, and presenting it in a set of useful reports?
Additional Experience with Startups
Some DaaS providers are better than others because they have additional experience with startups. Such experience should not be underestimated. Startups are a bit different when it comes to due diligence because they do not have a long history to look into. They traditionally do not have finances as solid as long-established companies.
The intangibles for startups lean more heavily on management teams, their experience, and their ability to adapt. And of course, a solid idea and reasonable business plan are essential. Investors have to believe that what they are putting their money into is worthwhile.
Experienced service providers know how to evaluate management teams. They know what to look for in terms of business models, mission statements, formal business plans, and even company culture. Without the ability to analyze such things, a DaaS provider is not much help to investors looking at early-stage opportunities.
Valuation reports are a particularly important tool for startup investing and mergers and acquisitions. But they are not the sum total of due diligence. In fact, they are but a small part of a much larger equation. The intangibles demonstrate as much.
