Editor’s note: Warren Weeks is the managing partner of The Compound Group, LLC, which offers technical due diligence services in the fields of compound semiconductors and advanced materials technology. He also is a co-founder and former Vice-President of Nitronex Corporation.In the complex world of leading-edge technology, technical due diligence or technical auditing can be an increasing headache for the venture capitalist and investment banking communities.
Though technology may only be a relatively small percentage of the overall business strategy for an established, well-entrenched company, this is absolutely not the case for many high-tech start-ups and emerging growth companies. Since most seed-stage and early round investments are made on the promises of new technology with secured intellectual property rights, it is paramount that the investors completely understand the science and fundamentals behind the patents, technology and manufacturing process.
Unfortunately, complicated jargon, various industry acronyms and “golden” research results often cloud the true picture. Outsourcing technical due diligence can be an effective way to overcome these barriers.
Parachute in —
Firstly, having a technically astute outside due diligence team parachute into an organization for a day or two is an ideal way to quickly gain a snapshot of where the technology truly is.
It is worth noting that due diligence firms should have no reservations about signing mutual nondisclosure agreements with the companies. Once these documents are executed (hopefully in advance of the actual visit), the due diligence team asks to meet with the technical management team as well as many rank and file engineers.
Since the due diligence team speaks the same language as the techies on the other side of the table, an open and fruitful technical discussion can be had without the usual nervousness surrounding a visit by the venture capitalist. Also, during the obligatory facility tour, the due diligence team can accurately assess the capabilities of the company since they should be intimately familiar with the tooling and equipment they observe.
What are expectations?
Secondly, it is important to agree in advance on expectations from your due diligence firm.
As a VC, do you want a quick thumbs-up or a thumbs-down? Do you want a detailed white paper cataloging their findings and impressions? Do you want the due diligence firm to continue to play a role beyond this first encounter?
Usually, sophisticated due diligence firms can provide patent portfolio reviews, competitor analyses and product roadmap evaluations. They may also be useful in setting realistic expectations for the technology and in assessing future technical milestone accomplishments. But above all else, the due diligence firm provides to the venture capitalists and investment bankers a neutral, unbiased view into the technology, unfiltered by managements’ enthusiasm.
What are qualifications?
When deciding on whether or not to employ the services of a due diligence firm, look for a few key credentials.
A good due diligence firm should have technical training and “been there, done that” experience. Look for individuals with start-up experience that have developed technology from the ground up. They will know the pitfalls and watch out for over-optimism and over-selling of the technology. Look for individuals and firms with knowledge of the internal workings of the venture capital community. It will make your interaction with them much easier on the both of you.
Ask for their hourly rate for small day jobs, but if you think the relationship might grow, ask for a quote on the project as a whole. Additionally, consider putting the due diligence firm on a monthly retainer. Due diligence firms are always gathering information on their targeted technology areas, so a retainer approach may provide you with the best access to their knowledge and information.
Outsourced technical due diligence is designed to augment, not replace, work conducted internally by the investing firm. Clearly, even if the technology gets a thumbs-up, a whole host of reason may still kill the deal, including unrealistic revenue projections, fading markets or extreme capital requirements. But instead of trying to become super knowledgeable in a complex technical area overnight after just reading a proposed business plan, bring in the experts.
Additionally, in today’s distressed economic environment with many deals being flat or down rounds, outside due diligence firms can play a critical role in assessing the progress and future direction of your portfolio companies. Again, their independence and neutrality can shed an interesting light on struggling technologies and troubled technology companies. Their work will help bolster your funding recommendation to your other partners or allay your fears and prevent a bad investment decision. Either way, the technical due diligence services will have proved valuable.
Warren Weeks is the Managing Partner of The Compound Group, LLC, a firm offering technical due diligence services in the fields of compound semiconductors and advanced materials technology. He is a co-founder and former Vice-President of Nitronex Corporation, a venture-backed, emerging growth company developing GaN-based microelectronic devices. Weeks has also worked at Cree, Inc. He graduated summa cum laude with a BS degree in Ceramic Engineering from Clemson University and has a MS degree in Materials Science and Engineering from North Carolina State University. Warren can be reached at warren@compoundgroup.com or his firm’s web site:
