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Preemptive Diligence: A Founder’s Solution to Preparing for Investor Scrutiny.

Preemptive Diligence - you'll get there eventually.

I wrote an article a few weeks ago on the Patterns of Due Diligence, which was prompted by a discussion with another DD provider on the ‘common issues’ we see. In addition, I listened to a Podcast where one of the large Due Diligence providers stated there was a ‘pattern in DD‘.

My thinking was, ‘If there’s a pattern, aren’t people wasting time and money, and can’t we identify those patterns before a firm goes into a sale or investment process?

When advising on technology due diligence, I often encounter recurring issues that seem to plague companies regardless of their size.

Whether you’re a lean startup or an established multinational, these patterns emerge across the board. Notably, many of these issues revolve around cybersecurity, a topic of paramount importance to investors.

Unfortunately, these problems often go undetected until the due diligence process is well underway—often too late for founders and investors to correct without significant effort.

Enter the case for Preemptive Diligence.

The Case for Preemptive Diligence

It’s disheartening when a promising investment falls through due to unsatisfactory due diligence results. This is particularly impactful on junior investors who have put considerable effort into vetting a potential addition to their portfolio, only to find their work was in vain.

Some investors might console themselves with the idea that at least they got some “free due diligence,” but that’s scant consolation for a missed opportunity.

This begs the question: Why not help founders identify these red flags early on in the due diligence process? Preemptive Diligence would address this.

The Proposed Solution

The Preemptive Diligence solution I envisage involves proactively screening firms using a subset of the due diligence questionnaire. We focus on foundational aspects, ensuring the basics are in place before moving ahead. This preliminary process would be broken down into phases:

  1. Access & Challenge: Initially identify the glaring issues.
  2. Remediate: Proceed to correct these problems, often working in tandem with the startup to find viable solutions.
  3. Transform: The business operates with less ‘obvious’ issues and can present a their firm in it’s best light.

This approach offers a win-win outcome for both founders and investors. While it’s unlikely any firm will score a clean bill of health, it does set the stage for continuous improvement, ensuring alignment with a growth plan.

The Flip Side

While the benefits are compelling, there are also risks. Implementing such a service would necessitate strict criteria for eligibility; not all companies are ideal candidates. The phrase “polishing a turd” comes to mind—if a company is fundamentally flawed, no amount of pre-screening will make it a wise investment.

Furthermore, conducting a preemptive diligence review might inadvertently sanitize some of a company’s ‘natural behaviours’. Such behaviours often give investors invaluable insights into trust, the company’s long-term viability and decision-making processes.

I’ll conclude with some questions.

While this approach won’t eliminate all risks, it presents a more efficient, cost-effective way for both founders and investors to navigate the due diligence process. Through this collaborative method, we don’t just point out flaws; we work together to fix them.

And it’s a particularly new idea – we already provide this service to corporate finance houses looking to put firms up for sale; and we also provide external preemptive cyber assessments of firms before they are acquired.

But I think it’s an interesting offer to help all parties along the investment and buying cycle.

Questions to consider are:

  1. Do you think preemptive diligence can replace traditional due diligence in some cases?
  2. Are there particular sectors where preemptive diligence would be more effective?
  3. What criteria would you suggest for selecting firms that are eligible for this kind of service?

So, founders, be prepared: know what red flags might arise during due diligence and take steps to correct them beforehand. After all, forewarned is forearmed.

And i finish with this great piece of advice from Steve Cherin at  Cherin Law Offices, P.C., ‘NO DEAL GETS BETTER AFTER THE LETTER OF INTENT’. Following Steve’s advice, if it all goes downhill after the LOI, you may as well climb a taller hill.

Hutton Henry
Hutton Henry
Hutton has worked with Private Equity Portfolio firms and Private Equity funds since 2015. Having previously worked in post-merger integration for large firms such as Ford and HP, Hutton understands the value of finding issues prior to M&A deals. He is currently the founder of Beyond M&A and provides technology due diligence for VC, PE and corporate investors, so they understand their technology risks before entering into a deal.

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