Investors analyze businesses through a rigorous due diligence process. This presentation explains how investment bankers go through business and legal & accounting due diligence before starting negotiations. It explains what entrepreneurs and startup companies should expect: extensive field visits, in depth evaluation of financial plans, and explains what goes into a Term Sheet. Presented by leading social advisory firm Intellecap, this slide deck was prepared for Sankalp Forum. The Forum is an enabler of socially oriented early-stage businesses, and catalyzes investments, mentors and international networks to do so. Read more about Sankalp at www.sankalpforum.com

1. Capital Raising for Early Stage Social Enterprises
July, 2013
© 2013 Intellecap. All rights reserved
www.intellecap.com

2. Agenda
Introduction
Session I: Knowing your Business
Session II: Approaching an Investor
Session III: Due Diligence and Negotiation
Session IV: Post Investment Challenges
© 2013 Intellecap. All rights reserved
2

3. After the initial discussions when you approached an investor,
the due diligence process is kicked off
Due diligence & negotiation
3
Subscription
Agreement
2
Term Sheet
1
Intent for Due
Diligence
Initial
Discussions
• Approaching the
investor
• Sharing the pitch
book
• Having initial 1-2
round of discussions
Business Due
Diligence
• Detailed discussions
• In-depth evaluation
of b-plan & field
visits
• Negotiations
• Investment
committee decision
Legal & Accounting
Due diligence
• Due diligence by audit
/ legal firms
• Negotiation
• Preparation of
Shareholders &
subscription
Agreement
Deal Closure
• Signing of
Subscription
Agreement
• Deal closure
• Money released
Completed
© 2013 Intellecap. All rights reserved
3

4. Business Due Diligence
Due diligence & negotiation
3
Subscription
Agreement
2
Term Sheet
1
Intent for Due
Diligence
Initial
Discussions
• Approaching the
investor
• Sharing the pitch book
• Having initial 1-2
round of discussions
Business Due
Diligence
• Detailed discussions
• In-depth evaluation
of b-plan & field
visits
• Negotiations
• Investment
committee decision
Legal & Accounting
Due diligence
• Due diligence by audit
/ legal firms
• Negotiation
• Preparation of
Shareholders &
subscription
Agreement
© 2013 Intellecap. All rights reserved
Deal Closure
• Signing of
Subscription
Agreement
• Deal closure
• Money released
4

5. The business due diligence stage is a time for in-depth
evaluation of your business
The main steps include:
Due diligence & negotiation
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
5

6. The business due diligence process starts with discussions
between investor and promoter
Due diligence & negotiation
1. Detailed discussions between investment manager & promoter/ promoters
•
Promoter provides various documents for investor‟s consumption & evaluation
•
During discussions Investor develops detailed understanding of:
 Growth plans
 Capital required
 Ball-park estimate of equity stake promoter is willing to part
Who is an investment manager?
• One of the key people from the investor‟s side
• Manages the entire the due diligence process
• Carries out evaluation & seeks clarifications
• Provides feedback to the investment committee
Be ready to answer all tough questions from this guy!!
© 2013 Intellecap. All rights reserved
6

7. The business due diligence stage is a time for in-depth
evaluation of your business
Due diligence & negotiation
The main steps include:
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
7

8. In-depth evaluation of business & financial plan
Due diligence & negotiation
Logic behind various assumptions of your business plan shall be evaluated and validated:
•
Targeted customer profile
•
Targeted Market share
•
Growth rates
•
Product/ service pricing
•
Capital expenditure workings
•
Working capital period
•
Cost heads
© 2013 Intellecap. All rights reserved
8

9. The business due diligence stage is a time for in-depth
evaluation of your business
Due diligence & negotiation
The main steps include:
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
9

10. Investor shall conduct extensive field visits
Field visits shall be conducted by the investor to:
Due diligence & negotiation
• Do a health check-up of existing manufacturing/ service facilities
• Check adherence to standard operating procedures
• Evaluate technological interface
• Meet middle management & assess staff capability
• Get a general feel of the operations and environment
The output of the field visit shall help the investor to challenge/ accept
business plan assumptions
© 2013 Intellecap. All rights reserved
10

11. The business due diligence stage is a time for in-depth
evaluation of your business
Due diligence & negotiation
The main steps include:
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
11

12. Expectations from both sides need to be clarified in this
discussion
Due diligence & negotiation
The investment manager shall have another round of in-depth discussions with the promoter/
promoters on:
• Doubts, discomforts and relevant clarifications
• His understanding and findings of their business
• Likely valuation of their business
• Promoter‟s expectation on capital and equity stake he is willing to offer
Watch Out!!
•
More questions from Investor? ? Does not mean he doubts you. Take it positively
•
Hiding facts?? Never try to do that. Investors are smart people, they can find out.
Be Confident & Transparent !!
© 2013 Intellecap. All rights reserved
12

13. The business due diligence stage is a time for in-depth
evaluation of your business
Due diligence & negotiation
The main steps include:
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
13

14. Investment manager presents the findings to the investment
Committee
Due diligence & negotiation
Presentation to Investment Committee by
Investment manager includes:
• Potential of the business and valuation range
• Promoter and management feedback
What is an Investment
Committee?
• Key risks attached to the business
•
Final decision making body
• Key anomalies and positive highlights
•
Comprises of all partners of the
• Investible – now, later, never
firm
• Recommendations on:
– Investment Range and suggested tranches
– Equity stake to look for
– Likely period of investment and exit options
© 2013 Intellecap. All rights reserved
14

15. The business due diligence stage is a time for in-depth
evaluation of your business
The main steps include:
Due diligence & negotiation
1.
Detailed discussions between investment manager & promoter/ promoters
2.
In-depth evaluation of business & financial plan
3.
Field visits by investor
4.
Discussion on & validation of key findings
5.
Presentation to Investment Committee by Investment manager
6.
Negotiations and preparation of term sheet
© 2013 Intellecap. All rights reserved
15

16. Negotiation Process
Due diligence & negotiation
• “If you can’t go around it, over it, or through it, you had better
negotiate with it”
• “When a man says that he approves something in principal, it
means he hasn’t the slightest intention of putting it in practice”
• “Any business arrangement that is not profitable to the other
person will in the end prove unprofitable for you. The bargain
that yields mutual satisfaction is the only one that is apt to be
repeated”
In business, you don’t get what you deserve, you get what you NEGOTIATE
© 2013 Intellecap. All rights reserved
16

17. Each party has some “Concerns”
Investor’s Concerns:
Promoter’s Concerns:
Due diligence & negotiation
• Current and projected valuation
• Lower valuation
• Risks associated with this investment
• Loss of management controls
• The fund's investment objectives and criteria
• Dilution of ownership
• Inadequate financing
• Key assets of the company if charged for security
• Employee dissatisfaction on external investment
• Liquidity of investment, security interests, and exit strategies
in the event of business distress or failure ("Downside
Protection")
• Protection of the venture capitalist's ability to participate in
future rounds if company meets or exceeds projections
("Upside Protection")
• Influence and control over management strategy and
decision-making
Common Concerns:
• Retention of key members of the management team (and recruitment of any key missing links)
• Resolution of any conflicts among the syndicate of investors (especially where there is a lead investor representing
several venture capital firms)
• Financial strength of the company post-investment
• Tax ramifications of the proposed investment
© 2013 Intellecap. All rights reserved
17

18. Before the signing of the term sheet , the are some key focus
areas for negotiations
• Overall valuation of the business
Due diligence & negotiation
• Type of securities & term of securities
– Preferred Shares vs. Common shares
• Broad understanding of investor‟s exit
– Tag along, drag along, IPO etc.
Broad contours and characteristics of the deal are finalized at this stage
© 2013 Intellecap. All rights reserved
18

19. Term Sheet
• Once the promoter have analyzed all key relationships, financial & structural factors from a risk-reward & control
perspective the end result is a „Term-Sheet’
• A term-sheet would typically set-forth:
– Key financial & legal terms
– Right & Obligation
– Responsibility of certain costs & expenses in the event of an unsuccessful completion of transaction
– Commitments for financing from additional sources
• There are a number of “Standard Term Sheet” clauses that include:
–
–
–
–
–
–
–
–
Type of Security
Dividend
Conversion
Dilution Protection
Voting right
Redemption
Registration Right
Liquidation Preference
–
–
–
–
–
–
–
Pro rate share offers
Board participation
Condition precedent
Covenants
Expenses
Use of proceeds
Exit
© 2013 Intellecap. All rights reserved
19

20. Legal & Accounting Due Diligence
Due diligence & negotiation
3
Subscription
Agreement
2
Term Sheet
1
Intent for Due
Diligence
Initial
Discussions
• Approaching the
investor
• Sharing the pitch book
• Having initial 1-2
round of discussions
Business Due
Diligence
• Detailed discussions
• In-depth evaluation of
b-plan & field visits
• Validation
• Investment committee
decision
Legal & Accounting
Due diligence
• Due diligence by audit
/ legal firms
• Negotiation
• Preparation of
Shareholders &
subscription
Agreement
© 2013 Intellecap. All rights reserved
Deal Closure
• Signing of
Subscription
Agreement
• Deal closure
• Money released
20

21. Legal & Accounting Due diligence
The main steps after the term sheet is signed:
Due diligence & negotiation
• Hire a legal and an audit firm to conduct a legal and accounting due diligence of the business
– It is mostly the investee company which pays for these services.
• Negotiation on key terms of the Subscription Agreement and Shareholder‟s Agreements
– Terms & conditions of voting rights
– Dividend rates & preferences
– Mandatory Redemption provisions
– Conversion features
– Liquidation preferences
– Anti-dilution provisions (or “ratchet clauses”)
– Exit
© 2013 Intellecap. All rights reserved
21

22. Understanding legal documents
• Share Purchase Agreement ("Subscription Agreement")
Due diligence & negotiation
• Shareholders Agreement
• Employment and Confidentiality Agreements and Intellectual Property Assignments, and Share Repurchase
Agreements
• Warrant (where applicable), Debenture or Notes (where applicable)
• Preferred Share Resolution (to amend the corporate charter) (where applicable)
• Contingent Proxy, Legal Opinion of Company Counsel and a Registration Rights Agreement
© 2013 Intellecap. All rights reserved
22

23. Subscription Agreement & Clauses
• Enlists all the material terms of Investment
• Serves as a form of disclosure agreement
• Subscription Agreement also provides certain conditions that must be met before closing the transaction
• Affirmative Covenants might include obligation to:
–
–
–
–
–
Maintain certain insurance policies
Protect intellectual property
Comply with key agreements
Prepare forecasts & budget for reviews and approvals
Ensure representation of investors in board of directors
• Negative Covenants might include obligation not to:
–
–
–
–
–
Change the nature of business or its capital structure
Declare any cash or asset dividends
Issue any additional shares or convertible securities
Excessively compensate any employee or consultant
Pledge any company assets to secure debt or related obligations
© 2013 Intellecap. All rights reserved
23

24. Shareholders’ Agreement
• Shareholders Agreement defines how the Company‟s Board will function, respective rights of the shareholders, and
exit clauses among others.
• New investors will normally require your principal shareholders and all earlier investors to be party to shareholders
agreement as a condition to closing the investment.
• Any existing shareholder or buy/sell agreement might also be reviewed for amendments or termination as a precondition to investment
•
A shareholder agreement can also contain restriction on:
• Transfer of company securities
• Voting provisions
• Right of first refusal
• Co-sale rights
• Anti-dilution right
An investor may also want to reserve a right to purchase additional shares of your preferred
shares to preserve their equity.
© 2013 Intellecap. All rights reserved
24

25. Employee Related Agreement(s)
Investors may also require key management personnel to execute certain agreements. These may include:
• Employee Agreements
–
Employee Obligations
–
Compensation Package
–
Grounds of Termination
• Non-Disclosure Agreements
–
Obligation to preserve company‟s intellectual property
–
Post-Termination covenants
–
Non-Compete Covenants
• Intellectual Property Rights / Assignment Agreement
• Share Repurchase Agreements (applicable to founders)
© 2013 Intellecap. All rights reserved
25

26. Deal Closure
Due diligence & negotiation
3
Subscription
Agreement
2
Term Sheet
1
Intent for Due
Diligence
Initial
Discussions
• Approaching the
investor
• Sharing the pitch book
• Having initial 1-2
round of discussions
Due Diligence
Stage 1
• Detailed discussions
• In-depth evaluation of
b-plan & field visits
• Validation
• Investment committee
decision
Legal & Accounting
Due diligence
• Due diligence by audit
/ legal firms
• Negotiation
• Preparation of
Shareholders &
subscription
Agreement
© 2013 Intellecap. All rights reserved
Deal Closure
• Signing of
Subscription
Agreement
• Deal closure
• Money released
26

27. Timelines
Due diligence & negotiation
3
Subscription
Agreement
2
Term Sheet
1
Intent for Due
Diligence
Initial
Discussions
• Approaching the
investor
• Sharing the pitch book
• Having initial 1-2
round of discussions
Legal & Accounting
Due diligence
Due Diligence
Stage 1
• Detailed discussions
• In-depth evaluation of
b-plan & field visits
• Validation
• Investment committee
decision
• Due diligence by audit
/ legal firms
• Negotiation
• Preparation of
Shareholders &
subscription
Agreement
Deal Closure
• Signing of
Subscription
Agreement
• Deal closure
• Money released
Ideal scenario – 6 months
Could be very subjective and depends on case to case basis
© 2013 Intellecap. All rights reserved
27

28. Agenda
Introduction
Session I: Knowing your Business
Session II: Approaching an Investor
Session III: Due Diligence and Negotiation
Session IV: Post Investment Challenges
© 2013 Intellecap. All rights reserved
28

29. Stage of the business at investment defines level and kind of
involvement from investor
Stage of
Business
Investment
Investor
Involvement
Concept stage
Start-up
Matured
Seed Capital
Growth Capital
Private Equity
HIGH
• Investor shall get involved in
key operational issues
• Could suggest tweaking with
the core idea/ business
model
• Shall help in building
contacts from his network
• Shall help in raising second
round of investments, if
reqd.
MEDIUM
• More strategic less operational
involvement
• Shall help in scaling up through
contacts/ sources from his
network
• May provide ease in finding
partners/ collaborators for
business
• May provide ease in access to
capital markets
• Shall help in brand building
© 2013 Intellecap. All rights reserved
LOW
• Almost hands-off from
operations
• Could help in inorganic growth
– suggesting acquisition targets
•…
29

30. Watch Out!!
• Working together with investors for the first time - Do not know how VCs behave.
• Transition from “Individual Control” to “Board Control”
• Increased time spent on shareholder communication
• Pressure of business plan growth projections
• Corporate Governance and Transparency in books of Accounts
The key is to WORK TOGETHER to
achieve more
© 2013 Intellecap. All rights reserved
30