The venture capital market is increasingly attracting new players. Nevertheless, the IT sector remains the leader in the number of venture transactions and the amount of investments attracted in the world, which is not surprising, since venture investment is almost the main source of financing innovation. In this article, we will consider some aspects of the Due Diligence procedure before venture capital transactions.
What investors should pay attention to when conducting Due Diligence in venture transactions and what aspects of Due Diligence are key, please read below.
Venture transactions are a type of financing for a starting business. This usually comes from venture capital firms that specialize in creating high-risk financial portfolios. With venture capital deals, the company provides financing for a startup company in exchange for holding shares in this startup. One of the important components of the venture capital investment market is business angels. It is they who invest in start-ups even before venture capital funds, it is they who prepare the ground for start-ups, some of which then fall into the portfolio of venture capital funds.
Prior to venture capital transaction
Firstly, the venture capital investor (business angel or fund) finds some new technology with the potential to become an influential player in the market. The task of the venture investor is to find a company that will grow many times over, recoup bad investments and earn profits from above. Moreover, it is better to find one superstar and lose money on other transactions than to get into several medium-sized companies. Then, based on this assumed potential, the investor expresses his intention to invest capital at an early stage in a company that has developed or owns a new technology.
Even after the investor has familiarized himself with the business processes of the company, worked out the financial statements, there may still be certain legal aspects that can and should stop the investor’s enthusiasm. And for the investor this will be a very good way out of the situation, without subsequent stresses and financial losses.
In order to mitigate possible risks, investors need to conduct Due diligence of the company in which they intend to invest, even before the venture transaction.
What is Due Diligence?
This is a thorough study of a potential investment or product to confirm all facts that may include verification of financial statements. Reliability check refers to a study conducted prior to the conclusion of an agreement or financial transaction with a counterparty, after which an analysis of all the collected information should follow, and as a result a detailed report.
Investors perform due diligence before purchasing a company's securities. A security check may also relate to a study that the seller conducts with respect to the buyer, whether he has sufficient resources to complete the transaction.
The audit should be carried out on a significant number of aspects of the company, but 3 aspects are always required. The result of such a check should be answers to the following questions:
- Who owns intellectual property;
- Who owns the shares of the company;
- Are there any problems with employment?
If there are problems in at least one of these points, then this may unexpectedly emerge later and have negative consequences just when the investor wants to sell the company and make a profit.
Why is it so important to find out who owns intellectual property?
In particular, for an early stage technology company, ownership of intellectual property is, if not the only, then the most important asset.
If the company is not the actual owner of the intellectual property, the investor’s investments may be in the zone of serious risk.
Investors must be sure that all the founders, employees, as well as contractors of the company have signed an agreement under which all intellectual property is assigned to the company.
The contract should include any intellectual property that is developed using the equipment of the company, while working in the company.
If there are registered patents, trademarks or copyrights, the investor must make sure that the ownership of the property is properly registered.
In addition, it would be very useful to have an intellectual property lawyer conduct a high level security audit.
At the beginning of a due diligence verification, the first thing an investor should pay attention to is the owner of the company, especially if a third party is applying for a stake in the company. Prudence here will be very handy, since at any moment a third party with contractual obligations may appear. This situation will create significant problems during the sale of the company. If you do not pay attention to this, the investor will pay a higher price than it would have been and previously assumed.
Venture capital investments are the most highly profitable and most risky investments in the world. When performing venture transactions, it is better to reduce risks, which is quite possible if a quality audit due diligence is carried out. Do not hesitate to contact the experienced IQ Decision lawyers who will provide assistance in the Due diligence procedure at all stages, which will become the key to concluding highly profitable venture transactions. You can also order legal advice on any issues related to conducting due diligence in venture transactions.