Meeting The Team
Company meetings as part of the due diligence process
Happy Thursday, 👋
One of the earliest uses of the term "due diligence" in a legal context can be traced back to the Roman jurist Gaius who used the term in his legal writings. The Roman principle of "caveat emptor" ("let the buyer beware") placed the burden of verifying the condition and ownership of property on the buyer. Fast forward over a thousand years and the United States enacts the Securities Act of 1933, which requires companies to disclose specific information to potential investors.
Most venture capital investments tend to be exempt from the 1933 Act as they are only offered to accredited investors. The exemption shifts the due diligence burden to the investors as there is no defined criteria mandating what information companies need to disclose. Venture capital investments, therefore, tend to be some of the most challenging in terms of due diligence, as companies often have limited operating history, are still refining their accounting and data management practices, and may lack historical performance metrics or indicators.
What’s Your Perspective
One aspect of due diligence is meeting with a management team, providing all parties an opportunity to learn more about each other and discuss specifics of the business. The meeting also tends to be one of the most unbalanced parts of the diligence process.
Each team approaches a diligence meeting from differing perspectives, so understanding how each frames the conversation becomes important when asking questions or outlining discussion points.
🏭 Company: Focused on presenting the best possible image of themselves and their future potential to attract investor interest.
💰 Investors: Seeking detailed information on company strategy and outlook, understanding how the management team interacts, and looking for reasons to invest or not invest.
Frank Discussions
In 2022 JP Morgan purchased Frank for $175 million. Last week the US Department of Justice brought formal charges against Charlie Javice, the founder of Frank, for inflating user numbers. Previously we talked about the fraud at HeadSpin which involved developing deceptive financials. Both companies managed to mislead well-known investors and financial institutions, reminding us that investors at every level may encounter due diligence challenges.
The Justice Department case against Frank details how the founder developed a database of fraudulent user data to support claims of having millions of actual customers. Conducting detailed diligence on financial or user data can be difficult and time consuming, especially for smaller investors. Instead consider focusing on the team as part of the diligence process to uncover subtle clues or areas of concern.
Meeting The Team
The case against Frank highlights due diligence meetings where the founder dominated the conversation, answering most questions “regardless of the topics of the questions”1. We appreciate eager founders, but when one person controls the company narrative in a diligence meeting it raises a level of concern.
During diligence meetings we ask questions of specific people on the team instead of leaving them open ended. If it is a technical question, we address the CTO or for marketing we would ask the CMO. When we use these directed questions, usually the person asked the question quickly glances at the founder to get a non-verbal cue to proceed. It can often be a sign of respect, but we also watch the follow-up body language. If the person answering the question looks at the founder during the response or if the founder cuts them off or interrupts we start to get nervous.
We also observe how a team interacts during a meeting and what occurs during breaks or before the start of a meeting.
Are people trying to physically distance themselves from the founder at the table?
Does the team chat amongst themselves during breaks or just sit silent looking through email?
Do team members interact with investors one-on-one during breaks?
Additional Thoughts
Uncovering fraud during the due diligence stage can be difficult if a team is small or the data is buried inside large data sets. Looking for small clues in how the team approaches discussions or answers questions provides incremental data points throughout the diligence process.
Often, a response of “I don’t know, but let me find out” can build more credibility for a team than struggling through a vague answer. It can be difficult for a founder or their team to admit not knowing something, but it demonstrates a level of confidence admitting to investors you may not always have every answer immediately available.
As uncertain economic headwinds prompt venture capital investors at all levels to become increasingly selective, the competition for capital could potentially increase the prevalence of fraud in the industry. Watching how a team interacts or responds during investor meetings can become a powerful due diligence tool.
Wishing everyone a great weekend,
-The Caymont Ventures Team.
Line 46 of the JP Morgan lawsuit filed against Frank in December 2022