Understanding Due Diligence

Why are some of the people who pitch businesses on KCB Lions’ Den promised investments from the lions, but the deals don’t materialise after the show, with some not getting anything at all?

What transpires? Thing is, while the Lions would want to fund all businesses they take up on the show, they have to perform due diligence before making any final commitments.

What then is this due diligence, you may ask?

Due diligence is an audit of a potential investment or product to confirm all facts. Examples include reviewing the value of the company as stated by the entrepreneurs during their pitch, reviewing all financial records, plus anything else deemed material by the investor. It refers to the care a businessman should take before entering into an agreement or a financial transaction with another party.

At Lions’ Den, one of the most common reasons that deals don’t materialise is because the business that the entrepreneurs pitched at the Den is represented in a misleading way to the Lions.

When the entrepreneurs are pitching on the show, the Lions do not know in advance about any of the entrepreneurs or the businesses they are about to pitch to them. This leaves the Lions with only the limited information that is presented at the time of the pitch. Therefore, just as in any investment deal, due diligence must be conducted afterward to confirm the facts and figures presented during the pitch before an investment is finalised and money changes hands.

Why do Lions perform due diligence?

1.   They want to know that what was pitched is factual, that there is accuracy and consistency in what was presented on the show and what they get to see in the business. Let’s take an example of sales. While on set, an entrepreneur will talk about their sales and profits but in the due diligence process you find out that those sales numbers are really unconfirmed or haven’t been realised. Other times legal issues get in the way, like when a patent an entrepreneur claims to own is actually owned by someone else and that’s a deal killer.

2.   They want to see if the entrepreneurs have passion and clearly embody positive traits and habits that will allow them to execute on their plan and grow their idea into a substantial company.

3.   They want to understand the business operations. They want to see if there are loopholes and gaps in the processes, understanding exactly where their money is going to go within the company, and how success will ultimately be measured. For example, sometimes the paperwork alone speaks volumes. If there are no books kept for the business and factual information is too difficult to get and impossible to discern, then that will make it hard to close a deal.

4.   They also look closely at marketing strategies like distribution plans, customer acquisition, and most importantly how the company plans to scale up.

5.   Lions also give a lot of consideration and thought to the vision and morals behind each company they invest in. If you do not morally agree in the direction the company should go, then you will most likely face challenges down the road. So they look for partners who share common and fundamental viewpoints and perspectives.

6.   When Lions do their due diligence, they will closely look at the pricing structure. They need to understand the costs of sales, production, wholesale and retail.

7.    The Lions are also careful to make note of all liabilities or other types of debts that have been secured by the company and its assets.

8.   Other reasons include the business strategy changing and either one of the parties not agreeing with the new direction.

In many ways, each of the Lions share similar best practices when it comes to effectively investing their capital. It is important for people to understand that the handshake on the show is just the beginning of a long process before the Lions finally make any investments.