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Investment Due Diligence

Updated:2017-8-14 14:24:38    Source:www.tannet-group.comViews:197

Due diligence is an investigation or audit of a potential investment to confirm all facts, such as reviewing all financial records, plus anything else deemed material. Due diligence refers to the care a reasonable person should take before entering into an agreement or a financial transaction with another party. When sellers perform a due diligence analysis on buyers, items that may be considered are the buyer's ability to purchase, as well as other elements that would affect the acquired entity or the seller after the sale has been completed.

An individual investor performs due diligence by studying annual reports, Securities and Exchange Commission (SEC) filings and other relevant information about a business and its securities. An investor verifies the material facts related to purchasing the investment and determines whether it fits his return requirements, risk tolerance, income needs and asset allocation goals. For example, an investor may read the company’s last two annual reports, several recent 10-Qs, and any independent research available. He can then develop a sense of where the business is heading, what market factors may affect the stock’s price and how volatile the stock is. The investor then has guidance on whether the investment is right for him, and how much and when to purchase it.

Process of Investment Due Diligence
Step 1: Analyze the Capitalization of the Company
Step 2: Revenue, Profit, and Margin Trends
Step 3: Competitors and Industries
Step 4: Valuation Multiples
Step 5: Management and Share Ownership
Step 6: Balance Sheet Exam
Step 7: Stock Price History
Step 8: Stock Options and Dilution Possibilities
Step 9: Expectations
Step 10: Examine Long and Short-term Risks

What are the Due Diligence Basics for Investing in a Startup
When considering investing in a startup, follow the above-mentioned steps, in addition to the startup-specific criteria below. Investing in a startup carries a high level of risk, so here are basic steps you should consider.

Include an exit strategy when planning: More than 50% of startups fail within the first two years. Plan your divestment strategy to recover your investments should the business fail. This safeguards you from losing all of your investment.

Consider entering into a partnership: Partners split the capital and risk among themselves. Thus, there is a lower risk, and you lose fewer resources should the business fail in the first few years.

Figure out the harvest strategy for your investment: Promising businesses may fail due to a change in technology, government policy or the market. Be on the lookout for new trends, technologies and brands, and harvest when you find that the business may not thrive with the introduction of new factors in the market.

Choose a startup with promising products: Since most investments are harvested after five years, it is advisable to invest in products that have an increasing return on investment (ROI) for the period. Furthermore, look at the growth plan of the business, and evaluate whether it is viable.

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