Early stage investors such as Sequoia Capital, Kalaari Capital, Helion Venture Partners, Nexus Venture Partners and Accel Partners, among others, are increasingly running checks on the personal lives of entrepreneurs, wary of extravagant, reckless, raucous, even promiscuous behaviour, before funding them.
They have approached a bunch of consultancies in the past one year to launch a personal due diligence on promoters of companies in which they were about to invest. Such exercises involve an element of stealth, but sources in these funds confirmed that such checks were carried out for most of the investments this past year and red flags were raised in a number of deals. The funds, however, declined official comment.
Consultancies such as Deloitte, KPMG, Kroll and Alvarez & Marsal, among others, which offer behavioural due diligence and forensic diligence, have seen a 20% rise in this business.
Evaluating Qualitative Risks
“Today, funds are backing the promoters rather than the companies, as new-age businesses have limited operating history. In such a scenario, evaluation of the qualitative risks becomes much more important,” said Nikhil Bedi, senior director, Deloitte India. Bedi heads the business intelligence vertical in his company.
Last month, Rahul Yadav, the cofounder and chief executive of Housing.com, a real estate search portal, was fired by the board for repeated instances of rude behaviour with various stakeholders. “The board believed that his behaviour is not befitting of a CEO and is detrimental to the company,” Housing.com said in statement then. The difficulty investors face is that promoters of most startups have no financial background that can be scrutinised.
Bedi said due diligences were even earlier carried out on promoters. With a change in the type of companies being funded and the average age of the entrepreneur, old-school checks have mostly become irrelevant. The number of such diligences by Bedi’s team has doubled to seven a month.
Going Beyond Antecedents
Checks now extend beyond the antecedents of promoters. The experience of seed investors, financialcommitments of promoters and their relationship with the team all come under the gaze of consultants. Dinesh Anand, partner and head of forensic services at PricewaterhouseCoopers India, said in addition to financial records, his team relies on public information. “We talk to professional and social acquaintances of the promoters for such checks.
These are done with the consent of the promoter,” he said. Recently, a global venture fund decided against investing in a company when it found the promoter led a lavish lifestyle disproportionate to the business’ state.
“We realised the promoter was taking home a fat pay package despite the business still being in an early stage and far from being profitable,” the managing director of the fund said. “Such businesses often risk siphoning of money or financial frauds by promoters.” An India-based early stage fund withdrew from investing in an IT services distribution company because the promoter forced his sales team to be unduly aggressive.
“We have observed cases where investment has been withdrawn due to promoters demonstrating certain behavioral concerns at the senior management level. This can potentially impact employee morale as well as the dynamics within the company, eventually affecting the business going forward,” said Bedi of Deloitte. Investors are also checking if promoters are promiscuous.
“Certain aspects of a promoters’ personal life may have an impact on the business in which case funds may ask us to focus on that as part of the due diligence process such as if the promoter has a serious health issue or has a lavish lifestyle which is not commensurate with his position in the company or issues of promiscuity which may impact the reputation of the target business,” said Reshmi Khurana, India head of global consulting firm Kroll.
There For The Money
Anirudh Suri, founding partner at India Internet Fund, an early stage investor, justified the extreme caution in investments. “A lot of people are there just because of the money,” he said, adding that his firm watches entrepreneurs for months and conducts thorough reference checks.
In India, most private equity and venture capital funds own minority stakes in companies. Ergo, enforcing shareholder rights is difficult. The prudence of funds thus isn’t surprising.
In at least one company, difference of opinion between two cofounders was cited as a red flag. Infighting and severe disagreements among promoters involving business plans and strategy can adversely impact the target’s future operations. Investing in such a target without being aware of promoter conflicts can put an investor’s capital at significant risk, said Dhruv Phophalia, managing director, Alvarez & Marsal.
Khurana of Kroll said funds also want to know whether a promoter respects the opinion of board members before taking a decision. “The entrepreneur’s attitude or behaviour with the board is important and often potential investors want to understand how the board functions and whether the promoter consults the board in the manner that would be considered desirable by the potential investor.”
Source : http://retail.economictimes.indiatimes.com/news/industry/fund-managers-hiring-consultancies-to-run-background-checks-on-startup-promoters/48399299