Due Diligence

Your Offensive Line, Your Offensive Weapon

Care and diligence bring luck. Thomas Fuller

Why Due Diligence is ImportantReturns are positively correlated to hours spent on due diligence

More than 40 hours = 7.1x returns

Less than 20 hours = 1.1x returns

What is the right amount of due diligence?

• Due Diligence Sweet Spot ~ 40 hours– Not an exact science and depends on the deal

• More doesn’t correlate to higher returns– Diminishing returns after initial threshold met

• Need to be intentional and deliberate when you perform due diligence – in other words:

Know what you are looking for and where to look for it.

Due Diligence Process

Phase I – High Level Sniff Test

Phase II – Deep Due Diligence• Using Mullins Framework• Due Diligence Checklist

© 2006 John W. Mullins

The Seven Domains of Attractive Opportunities

Macro Level

Micro Level

Market Domains Industry Domains

Mission, Ability toAspirations, Execute Propensity on CSFsfor Risk

Connectedness up and down Value Chain

Team Domains

Market Attractiveness

Target Segment Benefitsand Attractiveness

Industry Attractiveness

Sustainable Advantage

Due DiligencePhase I

Management Team Experience

Produce/Service Description IP Potential

Target Market Clarity Industry Definition

Valuation Reasonableness, High-

Level Financial Summary, Exit

Possibilities

High-Level Risk Assessment

Due DiligencePhase II

Management Team Analysis

Product/service comparison to direct

and indirect competitive offerings

IP research and investigation

Details on the target market and break-

down on the company’s marketing

plan

Competitive matrix with positioning

analysis

Valuation comparisons and detailed financial

analysis, exit scenarios and target ROI

Detailed risk assessment

Due Diligence Product/Service

• Features versus benefits• What is the pain being solved?• How does the product/service’s benefits

relieve that pain? • Current product/service alternatives?• IP potential?

Micro-Market Analysis• What benefits does the offering provide

that other solutions don’t?

Micro-Market Analysis

•What customer pain will the offering resolve? •How strong of an incentive do customers have to give you their money?

–Evidence?•Will customers purchase at a price that works for the business model?

Micro-Market Analysis

• What evidence can you provide to show that your target market has the potential to grow?

• Are there other segments that could benefit from a related offering? How do they benefit?

• Can you develop capabilities that are transferable from one segment to another?

Micro-Market Analysis

• How attractive is the micro-market?– Fit market into one of three buckets:

• Attractive• Fairly attractive• Not attractive

Macro-Market Analysis

•Secondary research

•Number of potential customers

How big is the market?•One

year growth?

•Two year growth?

•Five year growth?

How fast has the market grown historically?

•Next 6 months?

•Next 2 years?

•Next 5 years?

How fast will the market grow?

•Economic, demographic, sociocultural, technological, regulatory or natural.

What trends will affect the market?

Macro-Market Analysis

• How attractive is the Macro-Market?– Fit market into one of three buckets:

• Attractive• Fairly attractive• Not attractive

Industry AnalysisPorter’s Five Forces

Industry AnalysisBlue Ocean or Bloody Ocean

“Blue oceans….denote all the industries not in existence today – the unknown market space, untainted by competition. In blue oceans, demand is created rather than fought over. There is ample opportunity for growth that is both profitable and rapid.”

Bloody Oceans – industry characteristics where companies fight and primarily compete on price.

Industry Analysis

• How attractive is the Industry?– Fit industry into one of three buckets:

• Attractive• Fairly attractive• Not attractive

Management TeamExecution Risk

• Does the management team have the relevant experience necessary to execute the business plan?– Industry Skills?– Technical Skills?– Transferable Skills?

• Passion?

Management Analysis

• How attractive is the Management Team?– Fit into one of three buckets:

• Attractive• Fairly attractive• Not attractive

Financial Analysis

• What is the company’s revenue Model• Are the revenue projections realistic?

– Has the founders included the details on ‘how’ they plan on achieving these projections?

• Gross, operational and net margins?• Sources and uses of funds?• Projections

– Management, downside and upside scenarios?– ROI for investors?

Financial Analysis

• How attractive are the financial terms?– Fit into one of three buckets:

• Attractive• Fairly attractive• Not attractive

Risk Assessment

• Industry Risk– Changes to Porter’s Five Forces

• Market (Product/Service) Risk– Changes in customer preference

• Financial Risk– Appropriateness of fund sources and uses

• Execution Risk– Management team execution ability

Due Diligence Checklist

- Attachment

Efficient Due Diligence

• How can you work with others to share in due diligence tasks?– Angel groups/forums

• Deal flow• Collaboration• Leverage investor specialties/experience

– Lead investor strategy– Due diligence delegation based on specialties

Q&A

Ryan Goralwww.separtners-llc.com

Twitter: @ryangoral