Yamini | April 22, 2015

The due diligence process: Thinking about the business

The due diligence process is one of the first key steps any investor, incubator or funder undertakes while deciding whether to invest in or support the target enterprise. The process involves a deep-dive into understanding the enterprise from a business, financial and legal perspective and identifying key issues and risks. The information-gathering process includes both secondary research and one-on-one interactions with entrepreneurs and their teams, sector and product/service experts, customers, investors and others working in the sector.

While the diligence process is necessary from an investor/funder/incubator perspective, it can also add real value to the enterprise, particularly those in the start-up or early-growth phase. In fact during our diligences, we have often received feedback from entrepreneurs that Villgro’s diligence questionnaire, discussions and process were very helpful to them for thinking about their business strategy and operations in a more structured way, spotting issues and planning the way forward for the business.

Manish Kr Saraf (Ujjeewan)(right) speaks with Villgro CIO Mukesh Sharma (Left) about his business model

Here is a brief description of some of typical questions and issues that are sought to be examined in the diligence process:

1) Entrepreneur, Team: The background of the team, why the entrepreneur chose to start the business, experience, capabilities, commitment, team strengths and weaknesses, expertise.

2) Problem: What is the problem that is sought to be addressed and what are the causes for the problem? How big or severe is the problem? What are pain points of the customer or proposed end beneficiary?

3)  Current Solution: What is currently being done to address the problem? What are the pros, cons and gaps in these approaches? What more is needed?

4) Proposed Solution: Can the product/service offering address the problem? How? Does the solution fit with market demand i.e. are customers willing to pay? Do they see value add from the product / service?

5) Business Model: This includes understanding revenue streams, pricing, unit economics, the elements of the business model canvas (including key activities, resources, partners, value proposition, customer segments and so on), competition.

6) Innovation: What is the key innovation and differentiator (whether in relation to the product, service or business model)? Can it be and is it patented /protected?

7) Social Impact: What is the existing and potential social impact? On what parameters can or is social impact measured? The limitations or problems in reaching the desired level of social impact?

8) Scale: What is the potential for achieving scale? To what extent can the business, reach and impact be scaled? What are the challenges to scaling and ways to overcome these?

9) Investor perspective: Have others invested or otherwise supported enterprises working in this space? What market precedents exist in terms of the size of investment (or type of support), investor experiences and learnings, common challenges and expectations, returns and exits.

During the Villgro Fellowship, I have had the opportunity to actively participate in the diligence process for companies involved in different sectors. This has been a real value-add for me since I’ve had the opportunity to observe and experience first-hand the operational aspects of the business, what works and what doesn’t, the rationale behind the business model and the practical challenges faced.

Panel members at a greenhouse where Flybird’s low-cost, smart irrigation controller is successfully installed

Gathering insights directly and on the ground helps with correcting biases or assumptions. There have been instances where what looked like a difficult idea to implement on paper turned out to be a workable solution in practice, or vice versa.

For example, an entrepreneur may have a business model in which (a) the company provides a service that is only one part of the value chain in reaching the lower income segment, and is not the direct or final linkage in reaching this customer segment, (b) the service and business model in question is not innovative and there are other competitors in the sector. While this may not appear to be a winning idea at first glance, on further diligence and through first-hand interactions and observations, it may become apparent that the key factors that differentiate the model and make it a workable solution are: (a) a first-mover advantage in targeting a new customer segment (lower income), which differentiates the company from its competitors (who may not be interested in the low price model for this segment in the first place), (b) the enterprise has key partners and networks with the necessary experience and expertise that are able to get the idea off the ground and help in scaling operations, to ensure sustainability.

On the other hand, there could be situations where the product is truly innovative, is suitably priced for reaching the low-income customer segment, there is demonstrated need and interest for the product, adequate financial support for the company and a committed team but a closer look throws up the fact that getting the right distribution channels in place for reaching this customer segment, and therefore making any social impact, will be a huge challenge.

Talking to people who work on the ground and in the sector also helps understand real challenges and issues that may never be openly discussed in sources of secondary research. This includes issues in dealing with Government agencies, competitor tactics, legally non-compliant practices, or biases expressed by customers, distributors and salespersons regarding the product/service. For instance, for certain sectors or types of products, there could be a widespread and deeply held assumption that a higher priced product means better quality (and therefore a low priced product, even if priced as such to cater to lower income customers, will not be easy to market or distribute even for this segment).

Being in the field can also be an eye-opener in realising that for certain solutions to work, a lot more is needed than just providing the right product or service to the customer group. This could be through long-term government intervention – such as in the healthcare sector where the ability to make social impact in rural or semi-urban areas through a medical device designed for use by customers in these areas, is heavily dependent on the Government adopting the device at its health centres and hospitals. And of course there are always cultural and social issues that come into play – in one instance, a product designed for community use was installed by villagers in areas meant for ‘higher castes’ and a separate installation had to be done for use by ‘lower caste’ segments.

Observing such challenges on the ground first-hand can often be discouraging. On the other hand, these are of course the very issues that the entire sector is grappling with and working around. The premise and goal of social enterprise is to succeed despite these problems.