Is virtual due diligence possible?

Author: Matteo Ferroni

Estimated reading time: 5 min

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This article will try to exhibit how Venture Capitalists have been dealing with the fulfilling of due diligence during the Covid-19 quarantine period.
Additionally, it will highlight our contribution as a young fully-digital player in the European VC market.

What we mean by due diligence

Per se, funding in early-stage companies is hazardous. The due diligence process should pick the likely victors, recognize the critical perils compared with the investment and generate a risk mitigation plan with company administration.
Due diligence is a precise method that ascertains whether or not the venture capital fund or other investors will finance a startup or a more mature company. The process requires examining and answering a series of topics to appraise both the business and the legal aspects of the company. After completing the process, investors will use the results to conclude the internal consent process and complete the investment.

Communication is one of the most essential – and most careful to use – tools companies utilize daily. Behind any agreement organizations, there are valuable human interactions. The way we perform those interactions has recently witnessed transformations like, perhaps, we have never seen before.

What happens though, when in-person interactions or company visits are forbidden, but investors are still scanning for potential out there?
This constrained reality has created new obstacles but also new opportunities, particularly, for VCs, who exploit the power of due diligence in every transaction.

The more intricate the decision, usually, the longer is the study; In some cases, decisions require people to consider whether to put large volumes of cash in high-risk startups, with no guarantees whatsoever. It comes naturally, therefore, that such decisions involve a high level of analysis that leave the least details to chance.

Let’s hear some thoughts

From infinite zoom calls to drones for site visits, out-of-the-box solutions have been used to compensate for the impossibility to meet in person. Some venture capitalists believe that these changes have made some processes more efficient and that they are here to stay.
What is still to be clarified is whether the benefits of remote work, such as avoiding x-hour flights with all the related costs, outweigh the drawbacks.

An article from the FT features some interesting comments on this topic: Philipp Beck, an angel investor in Beijing, noted that even after the easing lockdown’s measures, they still preferred video calls As he explained: ‘Due diligence is 25% quicker’.
On the other hand, Niccolò Manzoni from Five seasons-ventures proposes a more conservative view: “We are not going to invest in a company without meeting the team directly. The deals we are closing are conversations which started [earlier].”.

According to a KPMG report, the global VC investment volume sank by $4 billion to $61 billion in Q1 2020 compared to the previous quarter. As for the global VC deals, they declined by 27%, falling from 5,820 deals in Q4 2019 to 4,260 in Q1 2020. The report highlights that the number of VC deals has not been this low since Q3 2013.
The outlook for Q2 2020 will not be this peachy: we probably need to wait for it in order to fully understand its global impact, as the venture capital workflow is oftentimes laggy, and rounds and deals are disclosed months after being closed.
New needs are arising, and technology is there to back them up. With the rise of VR and robotics, a future where investors could meticulously evaluate the quality of a plant while being on the other side of the globe does not seem too futuristic now.

Although there are many disagreements on whether this situation has provided more benefits or not, investors seem to agree that opportunities have emerged. By cutting the distance between VCs and startups, the global footprints can be expanded with investments that are not anymore restricted by geographical boundaries.
In particular, startups that are not located in important VC hubs can now fight for their shares of investments harder than before.

How has it worked out for us

This last point is very familiar to our values at GründerAtelier: since our inception, we have been focusing on high-potential startups from the Rhein-Neckar region as well as other German areas, which are far from big Hubs such as Berlin or Munich, however still having a very promising potential.

Furthermore, even though we consider VC as an environment in which relationships play an essential role, Covid-19 has, to some extent, beamed up ten years ahead. The deal closing process used to carry many inefficiencies, such as long meetings or unnecessary travels; now, they all have been quickly swept away. Will founders and investors still need to meet in person? For sure. Will they still need to meet in person for every matter? Probably not.

GründerAtelier has been able to interview, select and set up a eight-people team in just a few weeks; we are all working remotely from our hometowns, some of us have even taken the chance to work from some sweet holiday regions.
We are born digital, and we will probably keep on this track for our future. However, we too, have encountered some challenges: scouting in startup digital events does not have the same flair. For instance, when wanting to invest in a physical product, the prototype first screen is not so useful when it is on the other side of the screen (for software or service that’s another – more feasible – story). Also, we are putting more attention to financials than on people, since team due diligence is not so effective under this circumstance.

To conclude, the VC rule book for deal flow management process (from identifying new deals to calibrating existing portfolios) is now being rewritten. It is unlikely that platforms could ultimately succeed face-to-face networking, but they can undoubtedly bring benefits from both of the sides: startups which are not set in big hubs can expand their range of investors; likewise, investors can scale their scouting capabilities. This new approach translates to fewer formalities and more competitiveness, and we will try to exploit all the benefits that come with it.