Examining Accounting and Finance for VC Due Diligence

The venture capital (VC) industry is a high-stakes game, where informed decisions and meticulous evaluations often decide the future of a startup. A crucial part of this process is the extensive venture capital due diligence process undertaken by VCs before investing. 

In this article, we will walk you through the finer nuances of the accounting and finance aspects of this due diligence process and how VC portfolio management software can help VCs efficiently navigate it. 

Accounting Information: The Financial Heartbeat of the Company

Before diving into the specifics of a company’s finances, venture capitalists typically start by examining its accounting information. This represents the financial heartbeat of the startup, revealing the state of its fiscal health and operational efficiency.

One of the initial steps involves a thorough review of the company’s management accounts since inception. These documents, which include profit and loss accounts, balance sheets, and cash flow statements, provide an in-depth look into the company’s financial journey. They reveal how effectively it has been able to manage its revenue, costs, assets, liabilities, and cash flows.

Furthermore, it’s critical to understand which accounting standards the company adheres to. The most common are the US Generally Accepted Accounting Principles (GAAP) or the International Financial Reporting Standards (IFRS). The choice between US GAAP and IFRS can impact how certain transactions are recorded and reported, which, in turn, can affect the company’s apparent financial health.

A change in the adopted accounting standards can also be significant. Such a change could potentially mask fluctuations in financial performance, create inconsistencies in financial reporting, or indicate a strategic move to better reflect the company’s financial position or operations.

VCs also request the last and previous sets of audited accounts. These independently verified financial statements provide a credible snapshot of the company’s financial performance and position at the end of an accounting period.

Additionally, the company needs to detail any changes in its accounting reference date since its inception. This is important because it impacts the period for which accounts are prepared and could affect the comparability of financial statements.

Borrowing and Liabilities: Peeling Back the Layers of Obligations

Understanding a company’s borrowing and liabilities is a critical part of VC due diligence. The names and contact details of a company’s bankers can reveal the institutions willing to back the startup.

Details about all accounts held by the company, including current overdrafts or any borrowings, can provide crucial insights into the company’s liquidity and its financial discipline. Moreover, a company’s debt securities, mortgages, and any property used as collateral can reveal its debt profile and risk exposure.

Information about loans provided to the company by any third party, especially those associated with directors or shareholders, can shed light on how much the company relies on internal or friendly sources of financing, which might not be available in the future.

Moreover, venture capitalists review budgets and financial forecasts for the last five years to gauge the company’s financial planning acumen, its operational efficiency, and the likelihood of future profitability.

Information about grants received or applied by the company, details about credit sales, hire purchase agreements, leasing and/or rental contracts, off-balance sheet commitments, guarantees, indemnities, distributions paid, capital commitments and expenditure, and the company’s debt schedule further add to the comprehensive financial analysis undertaken by venture capitalists.

Acquisitions and Divestments: A Look into the Corporate Strategy

The acquisition and divestment activities of a company can reveal much about its corporate strategy and the associated risks. Outstanding or potential liabilities arising from any acquisition or divestment agreements can influence a VC’s valuation of the company and the price they’re willing to pay for a stake in it.

Details about any planned reorganizations within the next twelve months and previous reorganizations that have taken place can signal the company’s adaptive capacity in a dynamic business environment.

Finally, information about contracts to acquire or divest using company shares in the last five years can provide clues about the company’s growth strategy and its ability to execute it successfully.

Acquisitions and divestments are strategic decisions a company makes, and they offer a window into the company’s long-term vision, growth strategy, and risk tolerance. Understanding these can help venture capitalists (VCs) discern whether the company aligns with their investment thesis and risk appetite.

Outstanding or Potential Liabilities from Acquisitions or Divestments

When a company acquires another firm or sells off a part of its own business, there are often liabilities that arise. These could be financial, such as debts or contingent liabilities that the company has taken on, or operational, such as integration challenges in the case of acquisitions or gaps left in the company’s operations in the case of divestments.

Understanding these liabilities is crucial for a VC as they could affect the company’s financial health, operational efficiency, and future growth prospects. These factors will directly impact a VC’s valuation of the company and hence, the price they would be willing to pay for a stake in the company.

Planned and Previous Reorganizations 

Reorganizations are significant changes in a company’s structure or strategy, often associated with acquisitions, divestments, or changes in market conditions. Details about any planned reorganizations within the next twelve months or those that have taken place in the past can show how flexible and adaptive the company is in a dynamic business environment.

A company’s ability to plan and execute reorganizations effectively can speak volumes about its management’s competence and its organizational resilience. For a VC, this can indicate the company’s potential to survive and thrive amidst market fluctuations and evolving industry trends.

Contracts to Acquire or Divest Using Company Shares

Information about contracts to acquire or divest using company shares in the last five years can offer insights into the company’s growth strategy. Using shares to acquire another company could be a sign of aggressive growth ambitions. In contrast, divesting parts of the business in exchange for shares could indicate a strategic move to shed non-core operations and focus on the company’s strengths.

The success of these strategies would be reflected in the company’s performance post the execution of these contracts. This information can be valuable to a VC, as it indicates the management’s strategic thinking, execution capabilities, and the potential for growth.

Utilizing Edda’s Software for Enhanced VC Due Diligence

In conclusion, the complex and extensive nature of VC due diligence – particularly in relation to accounting and finance – cannot be underestimated. Comprehensive assessment of a company’s financial health, debt profile, corporate strategy, and more are critical for making informed investment decisions. 
Edda’s venture capital software tools prove invaluable in this regard. With its ability to streamline dealflow management, integrate with databases like PitchBook and Crunchbase, and facilitate real-time tracking of portfolio companies, Edda equips investment firms with the essential tools needed to conduct efficient and effective due diligence. Edda’s deal management software not only simplifies data gathering but also enhances the analysis process, aiding in the identification of potential risks and rewards. As such, Edda proves to be a game changer for VC firms, enabling them to make more informed and confident investment decisions.


Leave a Comment