Investment Due Diligence: Leave No Stone Unturned

Due diligence - a term bandied about readily with much confidence across many different sectors - broadly accepted as a process that underpins a thorough and confident appraisal of a specific business proposition, perhaps a significant merger, acquisition or other investment. At its most effective, due diligence arms a business with the facts it needs to make confident, astute decisions. At its worst, poor due diligence muddies already murky waters and potentially guides businesses down the wrong path.

To avoid the latter outcome, it’s best to avoid an off the shelf, one-size-fits-all process and instead adopt a bespoke approach that accounts for all inherent risks associated with a particular proposition.

Venture capital (VC) investment in FinTech - a booming industry - is a case in point. VCs have to understand complex business models and cutting-edge technology to pinpoint viable investment opportunities. Armed with millions, or indeed billions - $1.8billion was raised by UK FinTechs in 2017 - and facing fierce competition from other VCs, the panoply of risks presented by startup FinTechs could appear daunting.

VCs will often feel most comfortable assessing the viability of the business model, legal and financial aspects and will engage experts to evaluate the technology. That makes perfect sense. The success of a FinTech largely hinges on a successful combination of those areas and, more often than not, those are the risks most familiar to VCs. However, other stones sometimes remain unturned..

People risk is often overlooked or considered addressed through a simple criminal background check. With the wealth of information sources now available it’s perhaps remiss not to take a closer look at those who you’re investing in. Start-up scams are not uncommon in Silicon Valley; an early 2017 Fortune article explored the sector’s “unethical underside”. Are the founders who they say they are? How accurate are CVs and other stated accomplishments - the CEO of Wkriot pleaded guilty to fraud last month. Have failed attempts to fund other start-ups been disclosed, what about other initiatives that crashed spectacularly? Are other business interests in play that conflict with those of the VC? Many a business leader and politician have fallen foul of skeletons discovered in cupboards they’d long since forgotten about.

How about the culture of the firm? Is there evidence of unethical practices in the founders’ previous businesses? What does social media tell us? The merest hint of unethical behaviour could have a huge impact on culture of the firm, which in turn could lead to corners being cut, regulations not properly adhered to and risk decisions ignored or taken well outside of risk appetite.

Thorough due diligence of a FinTech couldn’t be considered complete without a close look at how its offer might be exposed to financial crime risk. The fledgling nature of the firm will mean a full risk assessment isn’t possible, but early inspection of the proposal will allow for an early judgement to be made on the type of controls and framework needed to deliver a compliant and secure product.

An effective due diligence exercise should alert a VC or other investment firm to concerns in any of these areas. However, if risks go unflagged through neglectful or absent due diligence they hold the potential to manifest further down the line with grave consequences for the VC and other stakeholders.

FINTRAIL would be delighted to discuss structuring a bespoke due diligence process for any aspect of prospective investments. Our team have deep experience in conducting due diligence for global banks, investors and government agencies and have a wealth of cutting edge tools at our disposal.