How investors can improve their RoI, writes Coller IP Management CEO Jackie Maguire

The report, which details the due diligence processes of early stage technology investors, found that variable returns from venture capital and angel investments may be explained by inconsistencies in due diligence processes.  The research identifies that some investors do not consistently follow a reliable and best practice due diligence process, and that the weighting investors give to assessing the different risks may be out of balance.   

The survey aimed to further understanding of the issues faced by investors: in both assessing the differing risks associated with making a technology investment and in the relative importance they placed on the key aspects of the underlying asset portfolio.  Most venture capitalists would say that they deploy a combination of research, analysis and gut instinct when deciding whether and how much to invest in a company.  The survey, however, shows the “hunch” factor as being very heavily relied upon when committing often substantial funds to the success of a company.

A further finding was that some venture capital firms, when undertaking due diligence, pursue a highly structured and formulaic process designed to optimise the efficiency of the exercise, with regular check points along the way to assess for deal breakers.  Others, however, are much more laissez faire, which is surprising considering the sums of money often at stake.

A key finding of the report is there is an over-reliance on the assumed ability of the management team to make the investment a success.  When survey respondents were asked which statements they most agreed with on a variety of issues relating to due diligence it was clear that most viewed the management and related issues as very important - but a significant proportion (10-20 per cent) did not see underlying IP or commercial issues as nearly so vital.

The results of the research would seem to indicate that variance in angel and venture capital performance may in fact be due to too much emphasis being placed on management strength instead of looking at the wider intellectual capital of a business. This is not just the IP behind a technology, but also areas such as market positioning, customer demand, supply chain processes, know how and branding.

In practice, the management team rarely stays in place throughout the life of the investment, so why, asks the report, are investors not placing more reliance on assessing the IP and commercial potential of the business prior to putting funds into a company, so that they know what they have invested in will have a great chance of succeeding even if the team is not perfect or will have to change?

There are around 26 “risk areas” to assess in an investment opportunity ranging from the legals and the patents to management, competition, business model and valuation.  The results indicate that only a small amount of time is typically spent on due diligence.  Even  based on three months (say 60 working days) of due diligence, investors are spending only 2.3 days per “risk area” and if some are really spending only two weeks (say 10 working days) they are spending only three hours on each one.  

Whilst respondents spent time on nearly all 26 areas, they spent proportionately more time on patents; management team and associated areas, for example key skills; corporate structure; and valuation and investment structure. This confirms that they place relatively less emphasis on what would normally be seen as the key commercial issues – for example, positioning, business model, branding and competition.

Management due diligence is still something that most investors undertake themselves, relying on getting to know the individuals they are backing through numerous meetings and telephone conversations over the due diligence period.  They may take up personal references and some venture capitalists will engage professionals to undertake psychological profiling and/or psychometric testing to assess the underlying skills of the team.  This, however, is uncommon.

Investors primarily allocated spending on expert advice to the legal profession – the lawyers for the legal agreements and the patent attorneys to check out the IP, but the amounts of money spent are very small.   Even then the investors’ responses relating to importance of external advice appeared contradictory.  Whilst some investors spend money on external advice relating to IP they do not agree that hi tech investing is primarily about protecting intangible assets as widely and deeply as possible.  They also disagreed that you should take as much professional advice as you can afford.  The results suggest that this sector of investors are perhaps placing an even greater reliance on the competency of the management team than might normally be thought, as in effect they are expecting the management team to derisk many of the commercial aspects of a deal - the venture capitalists are effectively delegating much of the risk management to the team.  They do expect to work very closely with the team in the early days post investment, but then pull back once the team is “up and running and proving itself”.

In conclusion, we do not believe that investors are wrong in placing great reliance on the management teams they back, but there does appear to be a relative inconsistency in how they value this emphasis, based on how much time and money they are prepared to spend assessing the team at the due diligence stage.  While they are relying on their judgement to back teams, the returns they are achieving appear to show that this is not, in fact, a reliable indicator of success.   If management are in effect being relied on almost 100 per cent to deliver returns post investment, why are investors not spending significant due diligence resources on assessing them? In particular, we would ask, why are they not spending a lot more money on professional advice on the management team?  Equally, judgment on management is being prioritised at the expense of fully assessing the non-people elements of due diligence, especially around wider IP and  wider commercial issues such as branding, market data, reputation and even tax advice. We therefore suggest that a review of due diligence processes by investors may be important in order to improve the returns on investments.

Read: Management, management, management - or what?

This report summary was written by Jackie Maguire, CEO of Coller IP Management.

Coller IP Management is a specialist in commercial intellectually property management and valuation. The firm works at all levels within organisations, from start-ups to multinationals, and with the investor community. For more information, go to www.colleripmanagement.com.