If you’re a first-time consumer good brand founder and seeking investment capital buckle up this article is for you!! In this article, I will be guiding you through some of the questions that come with the process of receiving that BIG “Series A” check. These are the kinds of questions that private equity firms regularly ask their prospective partners to answer. Remember these firms see hundreds of applications from all kinds of companies. Therefore, the success of investment capital firms is highly based upon their ability to efficiently identify a good investment proposal. The umbrella term to describe this process is called due diligence. The process of due diligence consists of the evaluation of the potential brand’s strengths and weaknesses. By going through these stages of evaluating the investment firm is able to evaluate the potential of the brand and analyze the risk of their investment.
The conduct of due diligence also involves asking a series of questions to evaluate the potential value of the company and also their legal aspects of opportunity. The investors will use the outcomes of this management activity to finalize the internal approval process and complete the venture. There are three stages of diligence that any venture capitalist firm must follow when they are investing in any consumer good company. The three stages are;
- Screening due diligence
- Business due diligence
- Legal due diligence
Stage 1 – Screening
The first stage of diligence is screening. The screening serves to filter out companies that do not fit into their portfolio or have a poor market fit. Investment firms typically have predetermined criteria for their potential partners this can extend even into a particular product category such as Sustainable Ventures which is specifically focused on Plant-Based brands and foods. Investment firms like anyone else are looking for a unique selling point and also a strong ‘moat’ to buy time against competitors and ‘me too’ product releases. Identifying if there is something in the supply chain that makes it very difficult for other products to quickly go-to-market or a patent at some stage of the product formulation is an example of a ‘moat’. In almost all cases a similar product will already exist in the market, a brand should be able to easily answer what makes this product superior.
Qualifying ‘what kind of growth’ a company has been seeing is a very popular topic these days. The basic aim of any investment firm is to ensure high growth rate. Several indicators can predict the revenue generation. The investment firm can ask several questions linked with the growth rate of their brand to evaluate their potential value. Some basic questions of this nature would be:
- What is your unit velocity? Of where you are available to be purchased in a retail location, how fast does your product move?
- What is the rate at which a customer purchases your product vs the benchmark of the category, is this a weekly buy, a monthly buy, a bi-annual?
- What is the rate of customer retention (how many customers have stayed on)?
- What is the rate of customer attrition (how many customers have stopped buying the product)?
- What is the rate of customer lifetime value (how many we can expect to earn from a single customer)?
- What is the rate of viral coefficient (company’s buzz on social media)?
- What is the profit margin across different channels that your product sells in?
- How likely are your customers to refer you to a friend or peer?
- Other details such as market share and market size, the location of the business and their plan to launch new products in the future as well could be looked at as well.
For a significant period over the last decade, many investment firms were looking for rapid ‘unicorn’ style growth to capture. In the current climate, there is an increasing awareness and demand for both growth & profitability. Having a firm grasp of the margin at each of your different channels will no doubt be an increasingly important question in these dialogues.
Stage 2 – Business
If the ‘screening’ is all about the market and your product. The second stage, business due diligence is a further analysis that will also review your team and processes. The investment firms wants to confirm that it is a quality brand and team. Four important aspects at this stage is include the management team, the market potential, to review of the product lastly to examine the business model.
Beginning with the management team a few indicators through which management teams can evaluate include; experience level of the management. There are plenty of great success stories of first-time founders but having the forethought to stack your team with domain expertise across your business units is a sure sign of a good company. Other indicators could include:
- Trustworthiness & transparency,
- Number of employees
- A sense of a unified mission
Financial validity is an important aspect of this stage of due diligence. Asking questions related to cash flow, cash debt, income status, quarterly projection, calculation of net gains and losses etc. will assist the investment firms to identify the winning proposal. Finding alignment around an exit strategy plan between both the company and the investment firm is also another essential part of this stage. If you find as a founder that your aim does not line up with what the venture capital firm is looking for, it is unlikely that the relationship will be successful. At this stage a firm may also be evaluating the competition and looking to benchmark growth rate to company size and scale to understand if the runway and whitespace that is in front is going to continue your current trajectory.
Stage 3 – Legal
After going through the two stages of due diligence comes the stage of legal due diligence. In this stage, if the investor will be bringing in a lawyer to ask their own set of questions. Four things are important in this stage e.g. patents, trademark, insurance and past lawsuits. Patents that the brand claims will be cross-referenced with the list of authorized or pending patents. Trademark is also a necessary component in this stage. The lawyer will want to ensure that the company or product name is unique. It is better to ensure that the name is not being used by any other firm in your product category, famously noted by cases such as Apple Records and iTunes not being able to have any Beatles Music!
Third is insurance. Investment firms in this stage ensure that in case of any misshape there is proper insurance available. The availability of insurance is important to protect against lawsuits such as someone getting sick in the consumption of your product or a piece of equipment in your production failing. Finally, is past lawsuits. It is vital to have a good idea regarding the historical involvement of the brand with the law. Ensure questions like; is there any dispute on a trademark? Is there any involvement with the law? If so then what is the condition of the lawsuit? Etc. As the past experience sometimes gave us the insight of the future thus, understanding the history of lawsuits is essential as well as necessary.
If you made it this far, hopefully, you learned a thing or two about where you are as a brand. If you have some gaps, that is expected! Having the perfect blueprint is unlikely for any first time founder. However if you have 70% of this already accomplished before you start looking for investment, your likelihood of success is that much more.