Could Due Diligence Impair Your Exit Strategy?

I have noted that, even during these days of the COVID pandemic, there is still a lot of money in the PE and VC world that investors must spend for firms to survive. 

PE and VC firms invest in companies with a plan to exit the investment in three to five years. The exit can take the form of another investment round at a higher valuation, an IPO, or the sale of the business altogether. Another dynamic is becoming increasingly apparent: PE-backed companies are having an increasingly difficult time implementing an exit and/or raising the next round of capital. 

Why the difficulty, when there is an incredible amount of money for investors to invest? 

The primary factor leading to next round challenges is the enhanced due diligence investors are performing now compared to pre-pandemic. The long run of economic gains nourished a confident exuberance in investors where the investor had to believe in a company’s financial projects similar to how Dorothy had to believe in Oz … without much evidence. The supply of capital outweighed the supply of companies to the point that investors were willing to lower the bar for the due diligence completed on sales and financial projections, data rooms, and balance sheet liabilities.  

The current atmosphere based on a stricter due diligence process represents a correction that goes back to the core fundamentals of investing. When the pandemic dust settles a bit, the correction will result in a more sustainable environment for the PE and VC firms. In the meantime, portfolio companies must place more focus on the following areas to support due diligence efforts:  

Data rooms. Companies that cannot produce supporting documentation for their financial and sales assertions are destined to fail due diligence. Deals fall apart when a company cannot produce contracts, proving professed commitments or demonstrating compliance with the contract terms. Be prepared for due diligence efforts by appointing a trusted, organized document manager to oversee your data room. Read more about data rooms here. 

Projections. Think like the investor—play a great game of Sesame Street and make sure that one of these things (your financial projections) looks like the other (your historical trends). Practice the dialogue spoken regarding your company’s future to ensure it rings true to what you can support based on data and research. 

Historical financials. Your financial data must be accurate and easy to follow by potential investors. When you produce complicated financials that require confusing explanations or take too long to organize, you put the deal at risk. Just like a burglar will move on from a house with a security system, investors are glad to move on to the next deal that requires less effort to close. 

If you are a founder or a C-suite executive of a fast-paced, growing entrepreneurial company, are you prepared for the next round of funding or other exit strategy? Let’s talk about how to begin organizing your data room, simplify your financials, and produce realistic, evidence-based projections that investors will find credible. I would love to speak with you about the challenges you face in preparing your exit strategy. I invite you to set up a 30-minute free consultation with me by clicking on this link to my calendar – let’s talk!