Valhalla Partners has started a venture capital fund with $ 177 million. They have started the process of due diligence of opportunities to invest the money. For the due diligence process they have formed a framework through which the due diligence to be carried out. The process which is to be followed is very rigorous in nature. It is the first time in VC industry Valhalla is going to carry out such a long and extensive due diligence process.

The problem faced by Valhalla is the dilemma whether the process being adapted by them is correct. How the entrepreneurs are going to react at the process. Is it worth investing more time in the process? Whether this is the perfect approach for due diligence or anything more or anything less is required

Factors affecting the Problem

Valhalla Partners decide to adopt a new process of due diligence because of the following reasons.

• By looking at the VC industry, they were surprised that there is no best practices followed by the VCs
• None of the partners have ever developed a framework for the process although billions of dollar is invested by various VC firms

But fact is that VC industry is driven by opportunity and risk. As evident from the case “How venture capitalists evaluate opportunities”, different people are of different opinion. Some look at the management team whether they can deliver result while many other consider the market size and growth opportunity of the idea. The investments done by VCs depend upon their risk appetite and the return they want. Some VCs don’t want to lose an opportunity, so they invest in the idea and later put things at place to achieve the desired return. Some others are cautious in their approach and do lot of investigation before investing the money.

In summary, there is no fixed approach followed across the industry, although the steps are same. This has brought Valhalla to a situation where they want to frame a process which will be right for due diligence process.

Approach for the problem

As already mentioned there is no right or wrong approach for the due diligence. The VC investment includes following steps:

(i) Sourcing and screening Investment Opportunities (ii) Due Diligence (iii) Investment terms and Negotiations (iv) Post investment monitoring (v) Exit

Sourcing is normally done through VC conferences or networks etc. The investment opportunities can be screened based on the theme decided by the firm. After that comes the due diligence process, which is a comprehensive study about the opportunity, the sector in which operates, the future growth scope, the uniqueness of the idea and entry barrier.

In this case TX is a company which is in the Enterprise Telecom Management space and provides software to monitor and control the telecom expenditure. As per the estimate given a Fortune 500 company spends almost 1% of its revenue on telecom expenditure.

The company offers a differentiated product in the market and the customers have also given feedback of being able to save around $500,000 after implementing the package. The company is a profitable company, has already signed up blue chip companies and has tie-ups with AT&T. Some of its customers have opted for the package based on a google search or its relation with AT&T.

In this case a possible approach for investment can be :-

• Study the market size and the market share commanded by TX
• Study the last two year financials and the projections and its correlation with the growth assumption
• Since the idea has already been commercialized, there is no need to detail on the technology
• Study the uniqueness of the idea and how big players like IBM may provide such package and if they provide how it will affect TX’s market

The questions asked by Valhalla are not so relevant in this context as the company is already into profit. Such questions can be asked for a completely new idea.

Recommendations:-

The team at Valhalla has spent 15 months over the due diligence which is quite a long time. After spending the time the company has produced a 22 page document with additional pages related to reference etc.

There can be two approaches taken by Valhalla while investing, one for companies that are already profitable like TX and other for new ideas which have not been commercialized.

In case of TX, the decision of investment can be made fast before others replicating the business model. As the team already knows about the competitors’ package and customer feedback, the financials of the last few years etc, the investment decision can be made only by deliberating upon

• Future plans of the company
• The market growth estimated and the company’s plan for coping with the growth
• The estimation of return and whether it matches Valhalla’s risk and reward profile

In case of new ideas for investment Valhalla can take the current approach, but with a reduction of procedure and time for due diligence.

As the next step after due diligence is the negotiation and this takes much time for agreeing on the term sheet by both parties, much of the time should not be wasted on Investment Memo.

The investment memo can be made short and concise highlighting all the broad aspects like market size, growth potential, barriers for entry, positive and negative and the risk and return estimation. Based on this memo, term sheet can be prepared as during negotiation of term sheet more things can surface and those will further add to the VC’s due diligence.

In summary, the approach of Valhalla is right but investment of such long time on preparing the Investment memo is not correct. With a short investment memo, they can go to the negotiation table and extract further information before taking the final step of investment.

1. How did Valhalla Partners look at investments and risk?

2. What were the top three risks facing Telco Exchange?