The due diligence process is never fun. Just ask Bob Moul, a serial tech CEO who is currently CEO of machine data intelligence platform Circonus.
“It can be overwhelming,” Moul says. “I mean, it's like right up there with a root canal. It can be really painful, particularly if you haven't taken care of the basics. I definitely was in that situation.”
At the ASPIRE Dealmakers Conference earlier this year in Philadelphia, Moul talked about how to prepare — and protect — yourself before and during the due diligence process.
Avoid administrative debt
The last thing anyone who’s trying to get a deal done wants is to be scrambling to find basic documents.
“So anybody out there who's early-stage or starting a company, start from moment one with just making sure that you file everything,” Moul says, adding that failing to file everything from the start means a company is collecting “administrative debt.”
“It's not fun when you have everything but the third quarter 2017, and they're like, ‘Well, why are you missing the third? What were you hiding in Q3 of 2017?’”
Founding documents, articles of incorporation, financial statements, the voter and stockholder agreement, client contracts, board minutes and board decks are all the obvious documents to file. But some things might not be as obvious. Like revisions.
“It's not enough to have all those documents, you’ve got to track all the revisions and amendments that were done to those documents,” he says. “The most painful two words in the process are: signature pages. It’s amazing how many times you go to get the documents and you've got three out of the five signatures and people want five out of the five signatures and then you find out the two people that you didn't have signatures from, well, they kind of left acrimoniously, and it's not going to be easy to track them down and get those signatures. So keeping up with those things is very important.”
Moul suggests starting a data room from day one. Whatever the means — there are SaaS-based data rooms like SecureDocs that are not that expensive — a data room offers a filing structure.
Other things to be on the lookout for: NDAs. Not only do you have them on file, but be careful about what’s referred to as residuals.
“There's this concept of residuals which basically say that everything you tell them, if they're able to retain it in their unaided memory, is now theirs,” he said. “That can be very scary when people start finding that in due diligence.”
Also be aware of assignment of inventions. Anyone who has worked on your IP and contributed to your tech should have an assignment of inventions clause in their contract.
“If you were unfortunate to have to go through any sort of reductions, were you studious about trying to get releases from those people, releases from future claims?” Moul says. “These are the types of things if you're not careful, you don’t want to find this out is when you're in a deal and you're trying to pull all this together and, ‘Oh my gosh, we don't have all of this documentation.’”
Prepared, but guarded
Moul suggests doing your own audit. Create a checklist of what you would be expected to produce in a deal, go through it and start filling in the gaps well ahead of formal deal preparation, so when the time comes either for a deal an exit, or even if you just raising money, you can save yourself the embarrassment of not being able to find this basic information.
While it’s important not to get embarrassed by having documentation requested during due diligence, it’s useful to be a bit skeptical, especially when sensitive information is involved.
“I think you could begin to sort of smell out situations where it is more of a hunting expedition and wanting to learn about your technology — obviously you’re bit more guarded,” Moul says. “Just because they ask you questions doesn't mean you have to answer them. And the technology due diligence at some of these bigger companies, if you’ve been through it with Amazon, you know that they have teams of people and they just wear you down over time.
“But just because they asked doesn't mean you have to answer. If it's super important they’ll come back and ask again.”
