Source: Brian Zimmerman – due diligence, sales forecast
Here are the three very important factors that venture capitalists look for when they perform due diligence on a potential investment’s sales organization:
- Avery clear understanding of its target market and buyers,
- A sales process that maps to those things
- A sales team that can be cloned to replicate the company’s previous success.
It’s rare that we find all of those components in one company, but that’s not the point. The purpose of performing due diligence on an expansion stage company’s sales organization is to confirm the future potential of the business and judge how prepared it is to scale and grow into a great, big company.
Which is why the last thing I’ll discuss in this series is so critically important. After all, venture capitalists aren’t charities. We exist, like any other for profit enterprise, to make a return on our product (which, as OpenView’s Nick Hammerschlag points out, is cash). So, what’s that oh-so-important final component of VC due diligence?
A forecast and pipeline review that shows substantial revenue potential.
Now, that doesn’t mean that the business has to be profitable right now. It means that, if a business is promising significant revenue in future quarters, we want to confirm that their forecast and pipeline information isn’t total garbage.
As VCs, there’s typically a number that we commit to in the quarter we make the investment. That number is usually based on revenue or bookings and can significantly impact the valuation of the deal itself.
For example, let’s say a company’s growth rate has staggered a bit, but they’re promising an uptick in the current quarter. I want to validate that by performing an objective analysis that proves their assertion. That might include evaluating things like:
- The names of the companies that they expect to close
- The realistic dollar amount of those deals
- The date they’re going to close
- The probability or stage of each deal based on the company’s sales process
- The definitive next step that will ensure those deals close
From there, I can look at each forecasted sale, examine the best and worst case scenarios that could impact each one, and determine whether the company has a buttoned-up forecasting process, or some framework built on pie-in-the-sky projections. We’ll also break out renewal business versus new business in the forecast due diligence process, allowing us to see where the forecast is more heavily weighted. Ideally, it should be on new business.
As for a broader pipeline review, the more it’s tied to specific details (sales process stages, probabilities, and date-to-close, for example), the more comfortable VCs will feel with its accuracy and viability. If it’s sloppy, inaccurate, or loosely tied to documented data, red flags will inevitably be raised.
Ultimately, a forecast and pipeline review during the due diligence process is about fact-based, objective validation. We don’t want to know what you hope to close in the next quarter. We want to know what will close. And we want to see supporting information, processes, and history that prove your claims.
The bottom line — and the underlying point of this series — is that venture capital deals can be made even if a potential portfolio company has done none of the things I’ve discussed in this, and previous, posts. But those deals are the exception, not the rule. The more that you can legitimately and explicitly present valid revenue potential to a VC, the better your chances are of signing a term sheet that can propel your business forward.
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides professional CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices in Charlotte, NC, the Triangle, the Triad, Southern Pines, and Wilmington with a team of more than 30 professionals serving more than 100 companies throughout the region.
