Killing me softly with your Due Diligence – By Deepak Srinath

(This post was originally published on the VC Circle blog on October 14, 2011)

Why does it take so long for a venture deal to close after a term sheet is signed? This is a question entrepreneurs often ask in despair. This interminable state of Due Diligence (DD) kills entrepreneurs and I can’t think of too many reasons an investor would want to drag the process (other than issues with availability of funds).

For those of you who may not be familiar with the Venture Capital investment process, after a termsheet is signed an audit firm and a legal firm are usually appointed to do a financial and legal due diligence on the firm. Sometimes there is a business diligence or a technology diligence added to this, but more often than not the fund does this on their own. Based on the findings of the DD, there may be a renegotiation of the terms (unlikely in early stage firms) and the lawyers then draft the definitive agreements which usually comprise the Share Subscription and Share Holders agreements along with a bunch of other letters, board resolutions, etc.

Every time we sign a termsheet for one our clients, I make it a point to ask the fund how long they expect the Due Diligence (DD) and agreements drafting to take. The standard reply is that if all goes well the deal will close within a couple of months. Every single time, this has proved to be untrue; our experience has been anywhere from 3 to 6 months. Sometimes there are genuine reasons for this, but usually it is a combination of ignorance, incompetence, apathy and ego clashes that cause this wasteful delay.

A few observations on some of these delay factors:

1. Lack of preparedness of the company – It’s easy to pass on the buck to VC’s, auditor or lawyers for dragging the deal; entrepreneurs first need to make sure their own house is in order. Bad or non-existent accounting practices and lack of regulatory compliance are very often the cause to delay.  I’ve heard many entrepreneurs claim they are so busy building the business that they have no time for accounting or compliance issues. All it takes is engaging a good CA firm and keeping your eye on them. If the entrepreneur is using an investment banker, make sure they provide a basic DD checklist in advance and get things in order.

2. Engagement model with audit and legal firms – Audit and legal firms must be engaged on terms that do not give them an incentive for taking forever. The fee for the assignment should preferably be fixed and not hourly billing. Moreover, there must be a show cause and penalty for delays beyond agreed timelines.

3. The fund partner is not driving the process- Sometimes, the senior partner in the VC fund does the deal and leaves it to the junior associates to handle the DD. The juniors are not able to drive the process and exercise control over the firms doing the DD. Partners should stay involved or delegate authority to their juniors and communicate it to the firms doing the DD. This way a fund can influence the DD process and make it move faster.

4. Data checklist relevancy: More often than not DD firms use a standard requisition list of documents irrespective of the target’s sector. Even though it gets clarified during the course of the DD, it always adds a couple of week’s worth of back and forth and mostly redundant work. The fund should make sure that instead of a standard template, a relevant data checklist is sent out.

5. Audit and law firms using inexperienced resources – The DD is not just about gathering data; it requires some judgment calls on what is important and what is not. Inexperienced resources getting stuck on issues that are irrelevant or minor have caused much delay. The fund should make sure that the DD firms they appoint provide adequate supervision of junior resources.

6. Lawyers playing ego games – My lawyer friends won’t like this, but I’ve been in situations where the lawyers representing the fund and the entrepreneur start playing games of one-upmanship and endlessly debating technical terms that have very little impact on the terms of the deal. This is a really tricky situation because even if the fund and the entrepreneurs sense this happening, there is a perceived risk in asking their lawyers to let something pass and move it faster. Nevertheless, funds and entrepreneurs need to be aware of this and discuss it with their lawyers.

7. Simultaneous drafting of definitive agreements – It could be helpful (especially in early stage deals) if the lawyers are instructed to draft the definitive agreements in parallel to the DD. If changes are required based on the DD findings, they can always be incorporated. This can save a few days, instead of waiting for the DD to complete and then start drafting.

8. Lack of trust between the fund and the entrepreneur – In the deals I’ve worked on, when the level of trust has been high between the entrepreneur and the fund, deals have closed much faster. When the entrepreneur goes into a deal wary that he is going to get shafted, every single point is debated endlessly and deals take forever to close. Trust is something that gets built over time and through a lot of intangible actions. I can only urge entrepreneurs not to get into deals where they don’t trust the fund’s intentions completely.

Ideally, all venture deals should close in less than two months. Hopefully, this will become the norm rather than the exception as the VC space becomes more competitive and entrepreneurs more aware.

 

 

Internet startups: The path to success – Alap Bharadwaj

With the e-commerce and internet space gaining steam over the past few months, the Viedea team decided to put together a business development exercise that focused on the new entrants into this arena. After speaking to in excess of 30 companies, analyzing their business models and understanding their challenges, I noticed some important trends.

1. The “me too” bane: I’m not sure if there is a dearth of good ideas out there or that Indian entrepreneurs lack creativity, but an increasingly large trend that has taken over the internet space is the proliferation of clones of successful websites from the west.

For example the success of Groupon in America has led to a slew of discounted, daily deal, group buying services based websites in India jostling for market share in an arena where they can only be 2 to 4 players that will succeed in the long term.

In my opinion if you cannot significantly differentiate your offering or provide a compelling platform, the mere aping of a foreign trend will lead to nothing but a failed venture.

2. Hygiene Factors: It still surprises me, how many aspiring Internet business fail to get the nuts and bolts right. You log on to a website that promises you the sky and the earth, but are unable to navigate, search, order, browse in a clear manner. When site design turns out to be poor a visitor is even less inclined to return.

The attitude that “if craigslist did it with plain forgettable site design, so can we” has got to go. Craigslist is a one in a billion company, and that story will probably never repeat itself.

A clean, crisp and engaging design is a must and should not be put off for later. Other factors like 100% functioning payment gateways, customer service numbers, bill generation, clear transparent reporting of extra charges etc are also overlooked just because entrepreneurs believe the “concept” is strong. The concept will get a venture no-where without the hygiene.

3. Business Plans: In today’s world of venture capital investments and blockbuster IPO listings it still surprises me that most young internet companies fail to build out strong forward looking business plans.

As an investment banker the question I look forward to asking most entrepreneurs is where will you be in five years in terms of revenues, profits, manpower resources and funding?

The largely collective lack of enthusiasm to provide an answer to this question is only second to the slipshod, half baked, not thought through, generic response of “$100 MM company”, in terms of disappointing interactions one can have with a burgeoning company.

Vision and holding your company to that vision are key in terms of success not only in driving business but also attracting investors and raising funds, even if the vision is realistic and conservative.

4. Angel Investment: Another surprising trend is the misplaced confidence most entrepreneurs in this space have in the belief that their ventures will be able to raise venture capital funds.

The tech world is not what it used to be and VCs are done splurging on anything and everything remotely connected to the Internet. Unless you are a second or third time entrepreneur with at least one very successful exit behind you, the odds of raising venture money are slim at best. Why so many entrepreneurs miss out on raising money from high profile angel investors is beyond me.

Angels are much more inclined to part with money for first time entrepreneurs, plus they bring in much needed experience on both the operational and execution fronts. Finally the value a high profile Angel adds to your company becomes immediately visible once the venture approaches VCs for their Series A.

Most VCs feel a much larger degree of comfort with an industry veteran on board and this actually leads to an acceleration of the entire fund raising process.

There are many tiny things that differentiate a successful venture from another, but making the four on top are taken care off will go a long way in ensuring the growth and success of young internet companies.

Ethics in our business – Uday Disley

If one ever thought about ‘ethics in I banking’ being an oxymoron, think again. It’s no different from all the other businesses out there, which are vulnerable to ‘ethical dilemmas’, on a daily basis. One might ask, if we are immune to questions of ethics.

No sir, sorry, most of often than not, we keep asking ourselves ‘whether we are in the right profession at all’, thanks to some unreasonable situations. So how do we go about life, well, without asking unnecessary ‘existential’ questions, our sagely stance has always been that, ‘this too shall pass’ and a chapter addition to the ambitious autobiography that one hopes to write.

If you ask any seasoned I Banker, he/ she would tell you that, one becomes wiser with experience, better if it is a bad one.

Our dilemma

Sample this, a client (prospective) has sub $1 Million in revenues, says that revenue is booked in one entity and expenses are booked in another, wants a minimum $12 Million to sell and says he is sitting on an offer already.

It gets even better, the promoters and their investors would like their purchase consideration to be paid overseas or if possible in cash. The best of us would say this person has smoked something very potent, but the tragedy is that, the deal is possible, at least theoretically.

The ethical dilemma is whether this deal is straight enough for us to be involved in or is this a opportunity for us to showcase our skills in structuring a complex deal. The big aside also is if this client’s thought process is like this, there is a good chance that we may never see our fees.

As has been our experience with some far thinking clients who have enough intelligence to think far in their business, but end up spending considerable amount of it on finding loopholes in the system and doing the disappearing act when it comes to paying their advisors.

So would ethics override anything that we do in business, well some very successful businesses seems to think so. The Narayan Murthys, Tata’s, Premji’s etc. at least have demonstrated remarkable success in not paying bribes, but only as we know it, but let’s face it we are not them until we are them.

Our cynicism

Recently there has been so much talk about corruption in the public domain, that one can only get more cynical about ethics, worst being that, one tends towards believing that nothing is straight forward in business at all levels (be it a huge scam or your day to day kickbacks).

Even we do get cynical about these things especially when you see some fellow I bankers fall in this trap, but our stance has always been to stay away from ‘Bad deals’ or ‘Unreasonable situations’. On the view that there will always be people who will take up these kinds of deals, well good luck to them and their ecosystem, we are happy to work with client’s who value what we value, even though the number is small.

What makes an Investment Banker good – Deepak Srinath

‘Jack of all, master of none’, I’ve heard that cliché used to describe investment bankers often enough. My reply to those who give me the Jack of all jibe is that we are actually fantastic actors. Everyday we play hustler, charmer, bully, hero, villain, peacemaker, instigator- a range that any Bollywood or Hollywood actor seldom portrays in an entire career.

Jokes apart, Investment Banking is indeed a potion with lots of ingredients, some well known and some secret, which go into making that brew called a star investment banker. At Viedea, we have our heroes in the investment banking community and have been lucky enough to interact and learn from many of them. While there is a high degree of individual personality traits that make them the successful, we’ve had insights into fundamental traits that are essential for any good investment banker. So here goes (in no particular order of importance):

1. Be like a sponge: Sector knowledge is important and most i-bankers have core sectors in which we have fairly deep knowledge. However, the world is evolving rapidly and sooner rather than later ‘sector expertise’ will become obsolete. I-bankers have to rapidly learn about emerging trends and businesses and develop a high level of general awareness and curiosity about our world. The best i-bankers I know are all voracious readers and absorb newspapers, blogs and all forms of information like the proverbial sponge.

2. People skills: This business is all about people skills. The relationships you build with you clients, partners, coworkers, etc, are really the only assets that an i-banker has. If you don’t have a “turn on the charm” button, you have no business being an i-banker. The most hard core, aggressive i-bankers can transform themselves into charmers at will. Of course, it helps if the charm and empathy is real and not put on.

3. Great Execution OR Great Sales & Marketing skills: I believe that most i-bankers fit into one of two slots – ones that have better execution skills and ones that have better sales and marketing skills. Of course, no investment banker can entirely fit into one slot and must do both. However, it is essential that one is clear about what his or her strength is and builds their forte accordingly.

4. Patience and Tenacity: Deals take forever to close. Deals that appear to be done and dusted fall off for the strangest reasons. Unless one has extreme patience and extreme tenacity, it is prudent to take up an alternative profession.

5. Hygiene factors: Financial modeling, valuation, deal structures, legal and regulatory frameworks- I call this the core skill of i-banking. This is the only skill that can be learnt or acquired. Some of it can be taught and some of it comes with experience. Many an Associate in an i-banking firm possesses this skill in ample measure but is unable to make the cut to a client handling role because they do not posses that other traits listed above.

I would also encourage all current and aspiring i-bankers to view this short video by David de Rothschild on what makes a good i-banker (http://www.rothschild.com/Careers/?id=media/video3).

He rates ability to listen, good judgment and focusing on your strength rather than trying to everything as key to being a successful investment banker. And no, neither David nor I have “GREED”, a la Gordon Gecko in our list of must have skills for investment banking.

The dark side of Investment Banking – Deepak Srinath

The deal that falls through at the last moment – an investment bankers worst nightmare! Be it Reliance-GTL, Bharti-MTN or smaller deals, every investment banker on the planet has had to go through this scenario – You’ve worked hard on an M&A or PE deal for over a year. Finally you have an offer on the table that your client has accepted and the diligence is going well. The chemistry between the two parties is good and they’re already discussing nuances of post merger integration. You’re fantasizing about your killer bonus and the BMW….and suddenly the earth caves in. For reasons completely out of your control, the deal falls through. You’ve made zero returns on your investment of months or years of work on the deal.

Catch hold of any seasoned investment banker sipping his highball at the Harbour Bar and he will tell you that it’s all a part of the game and this profession is only for the big game hunters who have the balls for the high risk-high return model. But this is exactly what gets my goat – why have we bankers reduced ourselves to bounty hunters who either hit that pot of gold or get killed by the alligators in the swamp. Do we not value ourselves as professionals, who deliver specific professional services at every stage of the transaction? Why then are all our contracts loaded on to that ‘success fee’? Look at lawyers for example – they may get a bonus for winning a case, but win or lose they get compensated for their professional effort. Same with every other professional service I can think of except maybe real estate brokerage. Even sportspersons get compensated based on milestones they achieve. Unfortunately, the success fee model has become such a norm that it is difficult to get a client to agree to a different structure, especially in a highly competitive and dare I say, commoditized market for i-banking services.

I have a very simple proposition for my clients – pay me for the work I do. Attach milestones to every step of the transaction process and compensate me for delivering it. Of course, there will be a component of the fee contingent upon ‘success’ of the deal. And what clients benefit by doing this- a) Accountability at every stage of the transaction b) Overall cost of the transaction reduced by 25-30 % c) Unbiased advisory because I have enough incentives to tell you what is best for you rather than just pushing you to close the deal.

Any takers or do we keep our hunting boots on?

Bangalore:Big deal or No deal? – Deepak Srinath

As an investment bank focused on Tech and tech enabled services firms, it would seem that Bangalore is the perfect location for us, right? Afterall, Bangalore is the tech capital of the country on any parameter that one may choose to use. The history of Indian tech entrepreneurship is full of success stories from Bangalore. However, we find ourselves in the middle of a very curious situation – We do not have a single client in Bangalore today. What’s more, in the last six months, we have hardly come across a firm from Bangalore that has really excited us.  Are we doing a bad job in our home turf or is there a more endemic rationale to this?

I set about posing this question to my colleagues in Viedea, VC’s ,  fellow I-bankers, etc and heard several interesting explanations. For one, they all agreed that they were seeing fewer ‘doable’ deals from Bangalore. (Now the word ‘doable’ in our industry parlance needs some explanation- It means that it is a VC or M&A deal that has all the hygiene factors covered – good entrepreneurs/management team, product or service addressing a large market,  solid business model validated by enough customers,  decent revenue and growth path, no complications or legacy baggage,  etc.).

A VC with one of India’s best known funds has this to say – Entrepreneurs in Bangalore understand enterprise services very well. Culturally and historically, this is their DNA. Therefore they have been able to build good IT Services, BPO, KPO, Analytics services type of businesses. These industries have all matured and compete on scale.  There is not much of an opportunity for a new entrant in this space and hence VC’s won’t invest. Moreover, those that haven’t scaled are languishing and may not be of much interest to strategic acquirers either.

Rajeev Agrawal, founder and MD of PE fund Ambit Pragma added another interesting twist – the first and second generation entrepreneurs from Bangalore (read late 80’s and 90’s) cut their teeth in the Wipro’s and Infy’s during their early growth phase. They were in many ways like the pioneers who ventured out ‘west’ and built the United States. They learnt how to deal with uncertainty, create new markets and built businesses from scratch. These skills were then put to use to create the Mindtree’s, Onmobile’s, Indecomm’s, etc.  Today’s executives in Bangalore’s mature tech industry learn a very different set of skills – managing scale, working in a highly process driven environment- not exactly the skills required to go out and build a start-up from scratch. Therefore, they may not equipped to become entrepreneurs.

While both these theories have merit, a very pertinent fact is that we continue to see plenty of startup’s from Bangalore, but very few of them are ‘doable’. I think the real reason is because the Bangalore entrepreneurs’ greatest strength (tech savvyness) is also his greatest weakness. He/She is enamored by a brilliant technical idea, but fails to do enough diligence on the market or requirements of the intended users.  The real opportunity today is for businesses that seek to serve the burgeoning Indian domestic market. In our interactions, we often find that entrepreneurs from Mumbai, Delhi and even Pune, seem to have a much better understanding of the market and consumers than those from Bangalore.  They build their products and services for the market and not the other way round, ie, build a product and then try to find a market for it.

We hope this is just a learning phase for Bangalore and we start seeing ‘doable’ deals from this city soon.  The city has some incredibly bright, tech savvy young people and it would be a pity if many of them don’t go on to build innovative, successful and large businesses.

The market for “nice” investment bankers..-Deepak Srinath

At a social gathering last week I was asked the usual “so, what do you do?” question by somebody I had just been introduced to. When I replied that I was an investment banker, I got an incredulous look followed by “But you look too cherubic to be an investment banker. You should have a sharp angular face and look mean. I suggest you change your profession, you just don’t look the part”. While this sounds like an amusing anecdote, I was left wondering whether this was a reflection on the profession or on me.

I recently read an article in ToI about an amusement arcade game called ‘Whack the Banker’ which was proving to be a big hit in the UK. The media of course, with predictable regularity profiles the greed and avarice of alpha male bulge bracket investment bankers who snatch food from the mouths of starving, homeless people to pad their own pockets. These are of course facetious extremes; reality probability lies somewhere in between.

In our own interactions with investment bankers, especially those in the mid market segment, we’ve generally seen a fairly well ingrained sense of ethics and fair play. Of course, we’ve had the odd case where a banker deliberately misrepresented facts about their client or tried to go behind our backs and poach our client. This said, the one aspect of i-banker behaviour we’d definitely like to change is the unnecessary posturing and game-playing that is almost de rigueur for every banker driven deal. I strongly believe that there is absolutely no gain in value that is derived from such posturing and it adds 20-30% to the time a deal takes to close. An honest dialogue between the bankers representing both sides of a deal will probably achieve better results for both parties and save a lot of time for all concerned.

At Viedea, we’ve always believed in the value of being honest, straight-forward responsive bankers who work with like minded clients. In fact, that is our USP in many ways, along with the emphasis on quality – quality clients, quality deals, quality employees and quality work. There is a market for “nice” investment bankers after all!

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