Starting a new venture is an exciting and risky proposition. It requires a lot of effort and patience to get things moving until the venture opens for business. Many factors like finance, capital, technology, products, plant and machinery, premises, legal and statutory issues, buildings etc have to be tackled. It has to require careful planning and any mistake in the process will put the venture in jeopardy and will also result in a loss for investors. This paper is a review of due diligence that should be practiced in the creation of a new venture. It will also look at how investors evaluate a start-up venture.
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Diligence can be defined as “conscientiousness in paying proper attention to a task; giving the degree of care required in a given situation.” (Noun. 2006). The word due is added to reinforce the amount of care that should be taken while starting a new venture. “The entrepreneur, as earliest investor, should pursue due diligence on their idea early and often. This due diligence precedes the decision to invest more time and money in their venture and involves attempting to identify and resolve the most critical uncertainties (unknowns) surrounding the new venture.” (Due Diligence). Any entrepreneur should some questions directed at himself. They include factors like whether the project will work out, whether the entrepreneur can manage it, whether there will be a market for the products, and whether the team is capable. Three components for the basis of a new venture and several questions should be raised and answered for each of the components. The components are the market, the technology and the new venture (business). Technology includes factors like level of technology needed, and whether the company can handle it. Market includes factors like the market in which the venture will operate, the competition, strategy for market penetration, and validating the market. For business, the questions to be answered are about the management and its board of directors. Factors like product differentiation and product mix are also important. The level, type and requirement of capital are also important areas in which diligence is required.
It is not surprising that potential customers will conduct an evaluation process before investing in the business. “A VC’s decision to invest in a specific venture is more than an evaluation of a given venture’s business model; it also takes into account the NVT members and numerous other criteria.” (Busenitz, Fiet and Moesel, 2005). VC stands for venture capitalists and NVT stands for new venture team.
The level of evaluation may vary from investor to investor with large ones following professional methods for this purpose. They have a procedure for evaluation which is given here. A study about venture evaluation processes “confirms that relatively consistent evaluation criteria are applied across the industry and corroborates previous models which suggest that the venture capitalist’s decision-making consists of several stages.” (Boocock and Woods, 1997). One important factor that will be studied is the innovation in business, product, and strategy of the new venture. Another factor is the need for the product in the market and whether there is value for the customer in buying the product. The margins that the product can provide will also be evaluated. (Venture Evaluation Process: Question #4: Are there margins? 2003). Another evaluation criterion is whether there will be enough volume to meet the objectives and goals of the venture. The demand for the product in the sense that whether it is a one time purchase or will be repetitive will also be considered. The length of the product life cycle will also be a factor. Another factor that will be evaluated is whether the capital requirements are sufficient to satisfy the above mentioned criteria. The final evaluation criteria will probably be the ability and capacity of the entrepreneur and the management team in carrying off the business to success.
Venture evaluation and due diligence are important factors in any new business start-up. If due diligence is resorted to by the entrepreneur, the venture evaluation process will also be smooth and satisfactory for the investors.
- Noun. (2006). [online]. WordNet. Web.
- Due Diligence. [online].
- BUSENITZ, Lowell W., FIET, James O., and MOESEL, Douglas D. (2005). Signaling in Venture Capitalist-new Venture Team Funding Decisions: Does it Indicate Long-Term Venture Outcomes? [online]. Entreprenuer.com. Web.
- BOOCOCK, Grahame., and Woods, Margaret. (1997). The Evaluation Criteria used by Venture Capitalists: Evidence from a UK Venture Fund. International Small Business Journal. [online]. Sage Journals Online. Web.
- Venture Evaluation Process: Question #4: Are there margins? (2003). [online]. Ron K Mitchell.