A major milestone in any deal is reaching exclusivity once a company and an investor execute an LOI. This typically comes after weeks of preliminary due diligence which, from the company’s perspective, can consist of conducting initial management meetings, providing product demos, posting materials to the data room, fielding additional data requests and engaging in subsequent functional area reviews.
Once exclusivity is granted, an investor will work through its confirmatory diligence. This can entail long lists of supplemental questions (often from third party diligence providers) to help the investor gain comfort in other areas of the business including legal, accounting, tax, technology and insurance. During this phase of the process, management teams can become overwhelmed by a seemingly continual stream of requests such that they struggle to see the light at the end of the tunnel. On top of that, emotions can run high as key terms are ironed out in the legal documents.
The byproduct of all this is that if investors are not careful, they may unknowingly be straining the relationship with management.
So how can an investor mitigate this potential risk and ensure alignment once both groups are on the same side of the table post-close? What else can an investor do to keep the management team excited and energized to hit the ground running once final signature pages are released?
At PeakEquity we approach these critical questions by leveraging our decades of experience working with and investing behind founders and strong management teams.
#1: Having a Two Way Conversation with Management
Just as any investor would expect full transparency from a management team, we apply the same standard to ourselves. Companies often anticipate initial conversations with investors to be one sided. Management may be coached by bankers or even other employees who have gone through similar processes to expect a rapid fire of questions from groups during these early discussions so those parties can swiftly get up to speed and come to a quick “go” or “no-go” decision. While this may arguably be an effective tactic from the investor’s perspective, it can leave management teams feeling exhausted and lacking a strong sense of the investor’s ability to add value post investment.
At PeakEquity we make a concerted effort to set time aside during our introductory meetings with management to give them a chance to ask us any questions on their mind. These questions could include topics such as how we operate as a team, our experience investing within a particular industry or even preliminary advice on any near-term scaling challenges the company may be facing. By structuring our initial interactions with companies to be more conversational in nature, we build trust between parties early on and lay the groundwork for more collaborative and productive discussions later in the diligence process and post-close.
#2: Deal Team Consistency
Management teams can grow frustrated if an investor’s diligence process forces management to constantly interface with different sets of individuals. For example, certain investors may have a rigid division of labor in that the sourcing team who takes the first call with management is comprised of a different set of individuals than the investment team which in turn is different than the deal execution team and ultimately the post-close value creation team. This can lead to inefficiencies, particularly if the respective teams are not in full lockstep with each other.
To avoid this potential pitfall, we have one dedicated team comprised of both investment professionals and operating partners working with the company throughout the entire deal lifecycle. We have found that continuity of the deal team gives rise to a more streamlined diligence process because it minimizes the risk of information and key learnings being lost in translation across teams. More importantly, it demonstrates to management that we want to be respectful of their time and are mindful that they still have a business to run at the end of the day.
#3: Conducting Management Meetings with a Tailored Approach
Management teams get excited when the individuals they are presenting to have relevant experience or skill sets that are highly complementary to the company. Since we evaluate new opportunities and conduct diligence with the same core team, we expose our operating partners to management early on in a process. These operating partners are individuals who we have worked with in the past and/or invested behind and who possess highly relevant industry, functional or domain expertise. As a result, we tend to focus the initial conversations around the market opportunity and core functional areas of the business such as go-to-market, product or engineering as opposed to the typical review of financial performance.
It may come across as counterintuitive for some, but our questions around historical financials, projections, retention metrics and other SaaS KPIs are generally reserved towards the end of the first discussion with management. Our philosophy is that a baseline understanding of the market dynamics, product and various functional areas within the organization (including their interdependencies) will provide the requisite context by which to evaluate the financials.
For example, if a company’s top line is accelerating, what is the real driver behind the growth? Is the company experiencing more favorable market tailwinds, better discipline around pipeline management, higher producing sales reps or stronger product adoption within customers’ organizations leading to more upsell? Maybe there is another factor at play or it is some combination thereof. By focusing on these topics early on in the discussions and including our operating partners who have “been there done that”, we can ultimately be a resource to management and start establishing a rapport with them from the outset.
#4: Creation of a 100 Day Plan
A central component to our diligence work on every deal is the creation of a 100 Day Plan which serves as the blueprint for our value creation initiatives post-close. The plan is the culmination of findings from our operating partners, third party advisors, market work, deep dive functional reviews and conversations with key business stakeholders (e.g., customers, sales and technology partners, vendors, mid-level management etc.).
Rather than presenting the 100 Day Plan in a prescriptive manner, we make it a collaborative exercise. We share our preliminary thoughts with management and thus give them the opportunity to provide input so we can incorporate their feedback into a final mutually agreed upon 100 Day Plan. During this planning process, it is imperative for management to have assurance that they will continue to be the ones running the business day-to-day. Establishing a plan that has their full buy-in and seal of approval is paramount.
One topic worth highlighting that commonly finds its way into our 100 Day Plans is organizational design. Many of the companies we work with are at critical inflection points in their overall evolution. Each day management is running a larger business than the day before. As a result, they may be scrambling to fill open positions but at the expense of giving adequate thought to the longer-term impact on the business and how those near-term hires may or may not be conducive to achieving the overall vision for the company.
A big component of our work on this initiative revolves around helping management strategically think through hiring the right mix of people who have experience in areas such as software, scaling similar sized businesses, working within a specific vertical or supporting a particular customer base such as enterprise accounts. Rarely will management teams find a candidate who checks all the boxes and so it is crucial to build out a framework early on that details what the organization should look like 6, 12 and 24+ months in the future. As an example, we may conclude with management that X% of all employees should have prior SaaS experience while Y% of future SLT hires need to have scaled businesses from $25M to $100M and “know what good looks like”.
The strategies noted above represent only a small handful of the many considerations that should be employed to drive towards establishing alignment amongst the investor and company management at close. One major benefit of a well thought out approach to implementing these strategies is that many are naturally interrelated (e.g., deal team consistency begets a more tailored diligence process), creating a force multiplier.
Above all else, deal teams should establish a regular cadence with management during diligence to take their temperature and get a sense for how things are progressing from their standpoint. Perhaps management is making good headway working through request lists, but struggling to appreciate why they are being asked to focus their time in a specific area. Rarely do diligence processes play out exactly as planned from the outset and so regular check-ins with management will help minimize deal fatigue and allow the deal team to course correct along the way if necessary.
What this all boils down to is that maintaining an open dialogue with the company and reiterating the importance of two-way transparency is central to a successful partnership.