Due Diligence: Preparing for investment opportunities

As we emerge from COVID-19 restrictions, many SME owners are looking to the future and the option of taking their business forward by seeking investment from private equity or venture capitalists. Amy Pierechod, solicitor at Yorkshire law firm Gordons, explores the process of legal due diligence by investors – and what steps SMEs can take to help ensure a smooth process to access funding.

The UK is often labelled the start up capital of the world, with an army of entrepreneurial men and women looking to grow their fledgling businesses. Over 1,100 new businesses are set up in the UK each day, which attracts more venture capital than any other European country and offers a wealth of opportunities for innovation and development.

As we continue our recovery from COVID-19, the focus turns back to growth and for many SMEs that requires investment. Fortunately, the outlook is promising. Research by the British Business Bank shows that more than half of UK business angels have continued to invest post Covid-19 and 72% of angel investors are confident about the future growth in value of their portfolio.

And this is certainly not a London-centric trend. Gordons is a corporate partner of NorthInvest, which sees our firm work closely with NorthInvest’s senior management team to connect and develop early-stage tech start-ups throughout the North of England. It is fantastic to see the investments being made in SMEs within our region too.

Seeking investment

For some SMEs, the opportunity to accelerate growth will come from Private Equity (PE) investment. PE firms are companies that invest in the capital of a specific enterprise in order to acquire a strategic stake in it, once it is set up as a successful unit. The capital injected by private equity firms in a company which forms a part of their equity capital is termed as Private Equity.

If the business is newer, venture capitalists may be the chosen route. Venture Capital (VC) refers to financing for start up companies and small enterprises where they may be a considerable amount of risk, but the long-term growth potential (and therefore potential return) is high.

Even earlier than that, there may also be the option of angel (or seed) investors. These typically invest in businesses that are so early-stage they only have a few customers, or even none at all. They could simply have a well-developed business plan, prototype or idea.

Either way, if you are considering seeking investment, or even selling your business, then you are likely to be asked to undertake legal due diligence to some extent. Legal due diligence can be a time- consuming process, so thinking about it now and taking steps to be prepared can really help.

The nature of due diligence – effectively a detailed analysis of the business, often done using intrusive and very direct questions – can be off-putting for some entrepreneurs. Evidence shows this is particularly evident amongst female entrepreneurs and goes some way to explain the funding gap amongst males and females when seeking investment in a new venture. However, this is a two-way street; if entrepreneurs want to exploit growth opportunities, then they must be willing to open themselves and their businesses up to scrutiny too.

Exploring due diligence

With this in mind, how can SMEs help ensure a smooth process to access funding? Here is what to expect from legal due diligence, including some of the main area that an investor may wish to focus on and what you can do to support the journey.

· Company information and corporate structure: This will usually require information on the company’s incorporation, who owns its shares and who are the directors. If your company has raised any previous finance or been a party to any acquisitions or disposals, then the documents should also be collated.

· Trading and commercial agreements: If you have standard written terms and conditions or any key written contracts then these are likely to be requested. Investors (and indeed buyers) will be keen to understand the terms on which the business trades. If any key contract is not formally set out in writing, try to put together the chain of emails or a spreadsheet or separate document so that an investor or buyer can understand its terms.

· Finance: An investor or buyer will want to understand any existing financing before investing additional money. It may be that existing facilities need to be repaid on completion.

· Property: Does your company own, rent or licence its office space? Have the full address ready, together with your lease or other agreements.

· Employees and pensions: An investor will inevitably be keen to understand the number of employees your company has and their terms of employment. It is a good idea to keep an anonymised list of your employees setting out key information like start date, notice, location, hours of work etc. A standard employee contract should also be provided. If anyone does not have a written contract (e.g. the directors) then a summary of their terms should be provided, although it would be preferable to arrange for the relevant individual to enter into a written employment contract. Details of any company pension scheme will also be relevant.

· Intellectual property: Consider what intellectual property your company owns or uses and on what basis it does this. This can include logos, names, designs, patents, rights in software, domain names etc. Investors and buyers will want to proof that the company owns or has the right to use key intellectual property so any registrations or licences should be provided.

· Computer systems: The level of detail an investor or buyer will want about the company’s IT system will depend on its complexity, how bespoke it is in nature and its importance to the business. Any IT which has been developed in-house should be identifiable as owned by the company.

· Data protection and compliance: Your investor may ask to see key policies to demonstrate compliance with data protection laws and other key legislation (e.g. anti bribery).

· Litigation: A potential investor will want to understand any risks associated with the company, which is why it is useful to mention and provide documents on any current, recent or threatened litigation. To contact the Gordons team, visit www.gordonsllp.com.

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