Michael D. Moberly May 21, 2009
The asymmetric risks associated with investments in early stage company’s, particularly those with intensive portfolios of intangible assets and intellectual property, have literally moved from being ‘just one more risk of doing business’ to inevitabilities when left unrecognized and unchecked which can execute to (a.) stifle a transaction’s momentum, (b.) undermine investors’ exit strategies, (c.) erode projected returns, and (d.) significantly devalue the invested assets.
When making ‘invest – don’t invest’ decisions, its essential today for VC’s and other investors to arm themselves with all of the risk mitigation weaponry available which begins by recognizing that 65+% of most investments’ value, potential revenue sources, sustainability, and platforms for future wealth creation lie, almost exclusively, with valuable intangible assets and intellectual property that may already may be in production/commercialization.
Due diligence must be comprehensive then, insofar as laying the necessary (additional) foundation to (a.) practice effective stewardship, oversight, and management of those invested assets, and (b.) have in place, best practices to sustain control, use, ownership, and value of those assets throughout their respective function – value cycles relative to the investors’ exit strategy plan.
A comprehensive due diligence engagement today must also provide investment principals with much more than mere ‘snap shots in time’ assessments or cursory audits of filings. While those elements are important and necessary to an investment, due diligence in early stage companies must also provide the principals with an objective and forward looking portrayal of the risks to key, revenue bearing assets at the center of the deal, again, the intangibles and IP.
This level of due diligence encompasses applying a business impact analysis approach to the invested assets and environment as a whole, with the objective to:
1. Identify, unravel, and assess the status, fragility, stability, and sustainability of the key assets…
2. Identify under-the-radar vulnerabilities known to be preludes to costly and time consuming (legal) disputes and challenges that can, and may already have entangled – ensnared key assets with absolutely no guarantee of an outcome.
3. Examine the intellectual – human capital underlying the investment by unraveling and ensuring the integrity of the origins of the idea and/or concept on which the investment is premised.
4. Examine the internal/external research and work environments in which the invested assets are being developed relative to identifying any loss, shrinkage, and sustainability issues that may be evolving.
5. Determine whether appropriate (adequate) measures-practices were in place prior to the invest decision, designed specifically to protect, preserve, and monitor the assets’ value beyond mere reliance on conventional intellectual property enforcements.
6. Leverage (newly) identified risks and vulnerabilities to the invested assets in (subsequent) deal – transaction negotiations.