As part of their new year's resolutions, many people decide to go into business for themselves. Others evaluate their current businesses to see how they are positioned to prosper in a changing economic and political environment and to modify activities which are no longer working for them.
As you move into a new year it is also a good time to reflect on an often neglected but nevertheless important issue, - that of due diligence. Most people don’t know what due diligence means and how to do it or possibly even why it is so important. So let’s take a look at why it is an important element in every successful business.
Due diligence is basically a fancy word for doing research. It’s a process of investigation and evaluation which you need to apply to any business venture or investment proposition. It applies equally whether you are starting a business from scratch or buying an existing business.
Some of your research will be conducted by telephone, over the internet, via fax, by letter and by observation and personal interviews. Some of it will require reading and much of it will require thinking and evaluating.
When you are starting a business from scratch your due diligence work is slightly more difficult than when you are researching an existing business. The reason for this is that you cannot refer to any historical data and you need to make intelligent estimates and predictions about what you think will happen and what you can achieve. Needless to say, if you are raising funding for a start-up venture, you will be held accountable for your predictions and will need to report back to your lenders on a regular basis. Since you will be spending your time and energy in this new business, it is also very important for you personally to make sure that you maximise your chances of success. Therefore the time you spend carrying out your due diligence work will be time very well spent. It is in fact, an investment in your future success.
When you are starting a new venture, it is imperative that you have a plan – a business plan. This business plan should address the major areas which need to be covered by your due diligence work. In other words, the due diligence work you do, will form the basis of the information which you will use in preparing your business plan.
I just want to briefly share with you an experience I had years ago when I started up my first business selling medical equipment. At that stage I had spent three years working in the accounting profession and eight years working in a printing, publishing and distribution company. I had decided it was time to venture out on my own. As you can probably gather from my previous experience, I had no knowledge of medical equipment.
Although I knew it would be a challenge, I was determined to learn and succeed in this new endeavour. Following that experience, I can tell you that regardless of how many businesses you have worked for and how much you have studied, it’s never quite the same as when it’s your own money on the line! It’s a case of learn fast or sink!
Whenever you are working for someone else, although you may have a lot of responsibility, at the end of the day, you can still walk away and the ultimate responsibility rests with someone else. When it’s your own money (especially if it’s borrowed money), the buck definitely stops with you.
Before I started this new business, I spent several months doing my due diligence work and preparing a business plan. At the time, I needed $75,000 to start the business. I prepared a detailed business plan and sent it through to my bank manager. The enclosed covering letter said that I wanted to start a new business and I would ring up in a week to arrange an appointment to come and see him so we could discuss funding for this new business.
Well, the week had passed and I rang him to arrange the appointment. He asked me: “When do you need the money?” To which I replied that I was ready to go ahead as soon as the funds were available. He said: “The funds are available to you as soon as you come in and sign the paperwork. I’ll have everything ready for you to sign in two days.” I couldn’t contain my amazement at the time and said to him, “But, I haven’t even come in to see you to discuss it.” To which he calmly replied: “There’s no need to come in. It looks like you know what you are doing so I’m comfortable with that.”
This was an important lesson for me and one which I’ve applied many times since then. Back then, $75,000 was a reasonable amount of money to raise for a small business, especially one in start-up mode, which you couldn’t just raise off the cuff. I had no external shareholders with this venture, so I was totally responsible.
I learnt that if you do your research well, think about and plan what you are doing and then prepare a good business plan so you can communicate your thoughts to others, you are already on first base. Although it involves a lot of painstaking work, this first step is the foundation for your future success.
So let’s take a look at what due diligence actually means and what you need to do in terms of due diligence for a start-up situation.
Just before I do that, I should just point out that there are other aspects of putting together your business plan such as clearly describing your vision for the business, your goals and much more. In fact, there are many good books and websites about preparing business plans so I am just concentrating on the due diligence issues here.
There are a number of key risk areas you need to focus your due diligence activities on when you are in start-up mode. The following questions are an indication of the sorts of things you would be asking when carrying out due diligence under each of these risk areas. In some cases you will be asking these questions of yourself if you are the entrepreneur behind the start-up venture.
- Development Risks
Does this new venture involve the development of new products and services?
How long will it take to develop these new products?
How much will it cost?
How will the development be funded?
How many people will be required (short term and long term)?
How will they be recruited?
How long before the venture can expect some cash to flow back into the business?
What performance indicators will be applied to test whether the development work is on track, within budget, marketable and competitive?
Who are the key potential clients who will beta test the product before it is released?
What reserves are available if the development costs exceed the budget forecast?
Who are the key people responsible for managing the development work?
What is their commitment to the success of the project? Do they have a vested interest?
What intellectual property is involved and how will it be protected?
What security measures will be implemented?
- Production Risks
Will the product manufacturing be outsourced or is an in-house manufacturing facility required?
If in-house, how much will it cost and how long will it take to establish?
What key staff are required to manage the production process and how will they be recruited?
Will they have a vested interest in the success of the business (i.e. shareholders, option holders etc)?
What equipment is required to handle the production, where will it be sourced from, at what cost, what training is required, what backup is available and what is the lead time for delivery and installation of the equipment?
Are special purpose premises required?
What quality control measures will be implemented?
Where will the raw materials/ingredients be sourced from?
What alternative suppliers are available?
What economies of scale can be achieved?
What security measures will be implemented?
What plans are in place to meet the forecasted sales growth?
- Market Risks
What is the market for these products and services?
How will it be serviced?
What is the competition?
What is the pricing of the product and how profitable is it?
How easy is it for a competitor to enter the market?
How can customer loyalty be created?
What follow on products are possible/likely?
- Management Risks
Who comprises the management, what are their qualifications and their previous experience with these types of ventures?
What is their commitment to the success of the venture?
Does the management team cover the key areas of research and development, manufacturing, marketing and sales, finance and administration?
What are the key performance indicators to be applied to determine whether they are succeeding?
- Financing Risks
What is the likely return on investment on the company’s product range?
How are borrowings secured?
What reserves are available to deal with budget overruns and sales not meeting budget forecasts?
What is the cost of finance for this venture?
What are the key performance indicators which need to be satisfied before further funds are released?
How can the management’s valuations be verified?
How long before the venture is likely to be profitable?
- Exit Strategy
Is the business being prepared for a public float (IPO)?
What is the likely private sale/takeover value of the venture?
What is the possibility of a management buyout and at what potential price?
What is the liquidation value?
Regardless of whether you are seeking to invest in a start-up venture, the entrepreneur behind the start-up venture, a potential stake holder (employee, contractor, supplier etc) or an entrepreneur looking to raise capital for a start-up venture, you will need to address these types of questions and more.
About Hans Jakobi
Hans Jakobi is an educator, author and investor. He is the author of six best-selling books including,
How To Be Rich & Happy On Your Income which is available at:
www.supersecrets.com and the presenter of the Super Secrets® to Wealth do-it-yourself real estate home study course. Join Hans Jakobi’s FREE Super Secrets® Online Newsletter
© 2002 Hans Jakobi. All rights reserved worldwide
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