In a series of articles commissioned by Intelligent Partnership, we asked industry experts RW Blears to share their thoughts on the current state of play in the EIS market. In the second article, written by Claire Pidancet, she gives us 10 tips to help make due diligence on single company EIS or SEIS investments easier.
1. Tax relief: For a SEIS or EIS investment, the first thing to check is whether the company has received advance assurance from HRMC. Ask to see a copy of the letter from HMRC. Although this does not give 100% certainty that investors will definitely be able to claim tax relief, an advance assurance does demonstrate that the investee company initially meets the criteria, based on the information provided to HMRC.
2. Intellectual Property (IP): Make sure the company you are investing in owns the IP. This includes IP relating to technology, but also brand, design and possibly copyright. Sometimes, the IP has been developed before the company is formed, and could initially be owned by a research institution or an individual, and it is then transferred to the company you are going to be investing. This is typically through an assignment or a licensing agreement. Ask to see the licensing agreement, and if it seems complicated, have it checked by a competent lawyer.
3. IP again: international patents can be costly, especially for start-ups. Make sure patent has been applied for in the countries/regions where the company intent to sell its product or services in the short to medium term. The commercial strategy should be in line with the patent strategy.
4. Financial Due Diligence (DD): ask to see the latest financial accounts and the latest management accounts. Check how much cash the company has been burning every month recently and compare this to the numbers presented in the forecasts in the first Business Plan you saw, if you need an extra financial advice visit https://www.ledge.com.au/.
5. Financial DD again: Also check how founders and initial investors invested into the company before you. Was it through straight equity, or through directors’ loan or a convertible loan note? Have a look at the account receivables to get an indication of how quickly customers pay the company: does this look in line with what you’ve been told?
6. Business Model: make sure the entrepreneur has a clear understanding of its business model and the key drivers behind it. What’s the gross margin, now and what is the scale further down the line? Which are the fixed costs and the variable costs? How sensitive is the gross margin and the bottom line to 5% change in price? Is there any currency risk?
7. Managing growth: are the marketing costs and the distribution costs in the business plan sufficient to drive growth? Is there enough HR costs budgeted, especially for sales and client support functions (there are usually underestimated). Has the need for future working capital been properly assessed? Remember, the biggest risk for start-up is to run into the wall because of short term lack of liquidity.
8. Commercial Due Diligence: what is the true picture here? How many paying customers (as opposed to nearly signed in prospects) does the company have? Is there one main client accounting for the majority of the revenues? If you are hiring a new accountant here are 5 reasons to hire local. How does the customer pipeline look like? Ask to see any internal CRM / pipeline document, even if it is only a spreadsheet.
9. Legal DD: there is so much to say here, but as a minimum, check that investors benefit from a drag along and tag along clause in the company’s articles of association, as this will be important on an exit. Check the size of any share option pool, warrants issued, etc. as this could significantly dilute an investors shareholding, so you need to know this. Also, check that each key members of the team have a proper directors’ contract including a good and bad leaver clause.
10. Entrepreneurial Team: this is the most important one and probably the most difficult to assess. It’s important to be checking CVs and doing background checks using sites like https://www.checkpeople.com/public-records. It’s equally important to go beyond that though, try to meet key members of the team together to assess how they interact with each other. Try to visit their office to get a feel of the atmosphere. If you get the impression it is a one-man-band after all (despite the glossy slides), pass your way. Check here to see more examples of how you can assess the key members of your team. Your start-up will need a front man with strong management and leadership skills and an effective and balanced management team to make it a success.