By Cris Miller

The other day I was reading an interesting article on Defensive Due Diligence by Claudine Cohen, Mendy Dwestel and Andrew Finkle (all from Grant Thornton) in the January 2010 of Mergers & Acquisitions publication of the Association for Corporate Growth.  They make an excellent case for doing sell side due diligence prior to the initiation of the deal.  They say "by performing due diligence that typically covers such areas as accounting, finance, tax, IT and compensation and benefits...prior to going to market the seller can address areas and avoid any unwanted surprises that can adversely affect the valuation and purchase price."  The problem is that, where as these areas are important, they are simple reporting matrix.  Yes get your reporting systems up to snuff but don't miss the important Stuff. The value isn't in the numbers - it is in what causes the numbers to exist.   Doing just part of the diligence is like having a 5 course meal and skipping the entrée.  If there were no product then the numbers would be Zero - thus no reason to do diligence of any kind at any stage.

Performing pre-sale Technology Due Diligence on the product and the market will have a significantly greater impact on the outcome of the deal and the future success of the acquisition or investment. 

No product is perfect.  Know where the deficiencies are.  If it is a software product, know what the software contains...such as what, if any, Open Source exists and what liability may exist with proprietary code or other IP so that when the buyer/investor asks the question, the answer is readily available.  This avoids delays, but more importantly, it avoids opening the discussions to further questions, doubts and trust.  With proper identification remediation activities can be accomplished prior to going to market -whether that is marketing the company for acquisition/investment or marketing the product for revenue and return on investment.  The market could be shrinking, or for that matter dead, and competition could be focused on to the next generation of the technology.   Customers could be in a state of transition.  All these situations will be missed or misinterpreted if you are looking only at historical numbers

Some investment bankers have a tendency not to want to "expose" the product deficiencies.  The diligent ones address the issues early in the conversation in order to either remediate the problem or have legitimate answers for the issues.  Ask and you will receive...ignore and the risk of discovery could be huge and the consequences could cost millions.

Here are just a few of the thousands of questions to ask when performing complete diligence.  The most important part of pre-deal due diligence:

1. What is contained in the product and product components? 
2. How old and ‘out of market' is the technology? 
3. Where does it fit with the advancing technology continuum? 
4. Are the development personnel capable of advancing the state of the technology?
5. Where is the competition regarding the existing product? 
6. What is the condition of the market itself - growing or declining? 
7. Where are the next revenue opportunities?
8. Where are the next markets for the product?
9. Are all the contracts for third party components in compliance?

So when performing "defensive due diligence" cover all the important areas of a business including finance, operations and most importantly, the product itself. After all, that is meat and potatoes on the plate - you know-the important stuff.

Cris Miller is Global Technology Diligence Practice Lead of Sema4 Inc., dba Semaphore (http://www.sema4usa.com/), a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for six Private Equity and Venture Capital funds and advises General and Limited Partners as well as Corporations around the world. Semaphore's corporate offices are in Boston with principal offices in New York and London.   You can write to Cris on cmiller@sema4usa.com.

Nice economy we're having, eh?  How's your company weathering this economic storm?

Picture the familiar scenario of a slowly sinking ship with its occupants desperately throwing valuables overboard to lighten the load.  Were you one of the valuables?  Has your livelihood been cast off? 

You would hope that when a company is struggling, it would have exhausted all other options prior to commencing layoffs. 

You would hope.

Picture the finance group. Yeah, those accountants and bookkeepers deep in the ledgers have been fully aware for months, quarters (or longer) that there was a leak.  Profits were diminishing; cash depleting; debits mounting; the balance sheet out of kilter; the company would need to adjust operations or it would begin to sink. 

Months pass.  New coordinates for the ship were set.  And reset.  But the hull is not holding up and things are getting a tad bit damp.  This is an all too familiar depiction of life in today's corporate America for the last 18 months.  And should it continue into next year it will get more and more difficult to right the ship. 

The accountant is handed the chopping block.  It's time to assign a value to each employee to determine who is expendable...who walks the plank...and when.

Who can replace whom at a lower cost?  Who can absorb so-and-so's duties?  It's messy, but the first wave of layoffs passes. 

State of morale takes one on the chin, but is largely ignored.  The remaining employees are just trying to survive.

Months pass.  If you are lucky.

It's Monday morning.  Yesterday's rock star arrives with his coffee and bagel, gets settled and turns on his computer.  But...his login password isn't working...

He nervously tries again...

(still nothing)...

Holding his breath, he tries a final time...

(nothing)

...And he is cast ingloriously overboard as he joins the flotsam and jetsam ranks of our sinking economy.

This chief petty officers opinion?  Too often we don't value the people who are closest to the situation. Listen to your finance team. Include them in corporate strategy discussion and tactical execution. Make them forward thinkers not just those who memorialize the last month or last quarter. In Semaphore's turnaround and workout business the finance team takes a prominent place on the bridge.  The captain, at times, needs to be led. A good crew with full knowledge will make the journey surer and all the shipmates safer and more secure. 

Linda Hachey is Director of Finance for Sema4 Inc., dba Semaphore (http://www.sema4usa.com/), a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for six Private Equity and Venture Capital funds and advises General and Limited Partners, as well as corporations, around the world. Semaphore's corporate offices are in Boston with principal offices in New York and London.   You can write to Linda at lhachey@sema4usa.com.

By Mark DiSalvo

I have been fielding these same questions from my GP, LP and other industry colleagues:

•  "What do you think about the ILPA Principles?" (soft voice)
•  "How do you think it will affect my business?" (worried voice)

• "They don't matter - we go through this every ten years when LPs try to get the upper hand." (with bravado)

Others are either more certain in their opinion or not so sanguine and believe that this effort will have a long term (and dependent on your perspective) positive or deleterious impact on the industry.  A few LPs, smaller ones and non-ILPA members are even cowed by the impact feeling that the "big dogs" are dictating their ability to enter into funding opportunities.  I've been most surprised by the few on the record comments by industry members and in particular the lack of specific statements by GPs. So...I thought I'd relate some of the conversations I've had these past days and share my expressed opinion. 

 It's pretty hard to disagree with common sense. I see nothing offensively troubling in the document (http://www.ilpa.org/files/ILPA%20Private%20Equity%20Principles.pdf).  In fact, it has offered a kind of first hand self-review opportunity for the industry.  I know.  I know.  We GPs are supposed to rebel instinctively against any proposal by an LP that governs or restricts our ability to do business. Bull!  We appeal to Pension Funds, endowments, banks and other institutions for fund capital and want as few restrictions as possible. After all, this is capitalism, no?  Atlas will not shrug his great burden but rather heave the world as we know it if these so-called Principles become ubiquitous.  Hardly.

OK, let's deal with the objection I most often hear when I mention my general support of the ILPA Principles, "But Mark, LPs are your clients. They give you the opportunity to triage or take over their troubled funds".  True. But no less than they are the client of every other more traditional fund. They give us all the opportunity to use our skills to generate opportunity for entrepreneurs, jobs for citizens, innovation for the public and profits that we GPs and LPs hopefully get to share. Sure, Semaphore's fund turnaround and workout practice depends on good relationships with and performance for LPs (the same as the rest of my GP colleagues) but this is only part of our business. Fully half of our professionals are engaged in the conduct of diligence on people, products, markets, strategy and technology for GPs (yes, those that will never require our turnaround services) who value the independent review of an investment judgment before they risk LP capital and their own carry opportunity.  It is this group of Semaphore clients that one expects has the most objections to the ILPA Principles.  In truth, extended conversation suggests differently.

Beyond the visceral reaction, there is need for deeper understanding of the moment in time in which we now conduct business than ever before.   We must rise above initial response to see our industry at a watershed moment. And we can lose the moment if we settle for the usual ad hoc proprietary negotiations that will get us, collectively, nowhere.  This is true of both PE and VC.    

Somebody once said that people change when they see the light, others when they feel the heat. There has been plenty of heat with the roiling of the marketplace, constriction of fund formation activity, difficulty of capital access and restricted liquidity opportunity.  Nevertheless I believe this is a moment of light more than fire.

I don't intend to take a point-by-point defense of the proposal. There may be one or two particular sentences that may seem to cross a long held and well trod line. But don't let your anathema to objectionable parts dismiss the value in the proposal as a whole. Take a breath then take a fresh read of the ILPA Best Practices enumerated. The Principles provide a "level setting" opportunity across the industry that will enable two things.  One, a fair and open platform between LPs and GPs that will afford, even accelerate, profit opportunity for both parties. And two, the best chance to put what could be a years-long, fund-by-fund battle to change the so-called power relationship between LPs and GPs. 

I'm not talking about GP surrender.  Good fund formation lawyers will and should protect the interests of GPs in negotiating LPA's.  Enlightened LPs know that there is elasticity in how the principles are memorialized in contract. However, if we cede no ground as GPs then disharmony and contention will become the hallmark of fundraising.  Commitments and allocations will both diminish as performance inevitably dips during this unnecessary boxing match.  We are all in a difficult enough environment that has too many of us suspect of "pay for play" fundraising and selfish exploitation of Limited Partner Agreements. 

One thing I do know for certain: I am likely to have fewer turnaround and workout engagements upon the adoption of these Principles.  A large proportion of the funds we take over are a consequence of governance sins committed by GPs and the lack of clarity in LPA's.  I'd rather redirect my company's growth in future years to the prevention of troubled fund situations. After all, when LPs have problem children it keeps them from spending time and money on the good relationships in their portfolio.  Selfishly, it might even help us grow our diligence and advisory practices. 

Francis Picabia is not a richly rewarded GP or powerful LP. Rather he was an artist who famously said "Our heads are round so that thoughts can change direction." Run these Principles around your mind a few times.  I believe you will see the bright and profitable path that LPs and GPs should walk together. I contend that general support of the ILPA initiative will reward the industry with long term - even decades long - "peace" between the parties, a more robust fundraising environment, and opportunity for larger profit sharing for each.

Mark S. DiSalvo is the President and CEO of Sema4 Inc., dba Semaphore, a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for six Private Equity and Venture Capital funds and advises General and Limited Partners as well as Corporations around the world. Semaphore's corporate offices are in Boston with principal offices in New York and London.

Posted by Louise Martineau on Mon, Nov 30, 2009 @ 01:15 PM

In a time when people are stressed about their jobs and doing what they have to in order to survive, it is a comfort to be working with a select group of individuals who can stay calm under pressure and work as a team to get the job done in a professional manner. My responsibility for leading our back office, operations, and contract teams demands it.

Situations arise from some of our Limited Partners where they are looking for specific information and backup on situations that have happened in the past - sometimes the very distant past.  I am confident when I rally the troops together to discuss the situation, that between all of us, we will be able to give them the answers they need.  Recently, a newer employee from one of our LPs called asking for backup on a situation from 5 years ago regarding the removal of another LP about a fund we took over from a General Partner who needed to be replaced for fraud.  Let's just say the files and records we got were not in the best of order nor were we certain anything documented was necessarily true.  Between all of us, we were able to pull the needed documentation together, verify it and answer the LPs questions with confidence.  This allowed them to close the then outstanding issue and move on to other more pressing needs.  The LP referred to this issue as "archeological" for them and was very happy to be able to tick if off their "to do" list.

When a customer is in need of assistance, a company needs to work together to make sure the necessary agreements, final documents and a commitment to "customer service" are all in place to ensure a smooth future relationship.  Follow-up and willingness to take clients through each step until they are completely satisfied are what makes a successful services company and inspires confidence in our clients to work with us again. You see- establishing good processes and good attitudes is a selfish endeavor and in the end, makes both client and colleague happy.    

I'm the youngest of six sisters and my mother taught us that if you support each other and don't point fingers, it will show in your work.   No one is perfect. You will have dysfunctional moments but working as a team is the best way to show your customers you are competent. Not a bad lesson.  Thanks Mom!  

Louise Martineau is Director of Operations of Sema4 Inc., dba Semaphore (http://www.sema4usa.com/), a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for six Private Equity and Venture Capital funds and advises General and Limited Partners as well as Corporations around the world. Semaphore's corporate offices are in Boston with principal offices in New York and London.   You can write to Louise on lmartineau@sema4usa.com.

Posted by Mark DiSalvo on Tue, Nov 10, 2009 @ 12:41 PM 

I'm a morning person.  No, not the kind you are thinking.  The type that goes to bed at 2:30 or 3:00 AM.  You won't find me at a power breakfast at a fancy hotel at 6:30 AM as I'll be making breakfast for my 12 yr old daughter Celia and then jumping, OK, reluctantly climbing onto the treadmill.

My colleagues at Semaphore know that I will handle any evening event or red-eye required travel with abandon but asking me to be presentably lucid in the morning is an effort.  Nonetheless, I accepted an invitation to speak at a recent T-Cubed seminar to discuss VC consolidation.  Wheeling slowly down Rt. 93 and 95 (the roads are a lot emptier in the evening) grinding to the Foley Hoag Emerging Enterprise Center, I reflected on the VC industry.  All too often we at Semaphore in our funds-under- management practice see the worst - disengaged, incompetent sometimes outright criminal General Partners as we take over trouble Venture and Private Equity funds. On the other hand, it is pretty small proportion and many outstanding GPs work assiduously, engaging Semaphore for diligence on people, process, markets, strategy and technology to help make the right decisions.  

At 7:15 AM a room alive with beaming chattering entrepreneurs and PE professionals greeted me at the event cosponsored by RSM McGladrey, Silicon Valley Bank and Foley Hoag.

70+ of my newest bright eyed and ebullient morning friends quickly gathered, coffee cups in hand and half eaten bagels aside and got down to a "down" discussion. There's not much fun in talking about Venture Capital industry consolidation.  I'll leave my fellow panelists to speak for themselves except to say that Michael Greeley of Flybridge and Alain Hanover of Navigator are decidedly morning people in the more traditional sense, being more awake than this correspondent, as they capably presented chilling facts about the steep drop off in fund commitment (both in numbers of General Partnerships funded and the aggregate amount of dollars committed) and cogently offered the gathered entrepreneurs personal experience and simply great advice on how to deal with the adverse conditions of the moment.

I stated that we should welcome the consolidation of the industry.  All too long I have seen General Partners who should not have been funded get funds. Companies that should not have been started were flooded with millions of dollars.  Fund and effort that was unsurprisingly unproductive and portfolios that offered no return to the well meaning but under-skilled entrepreneur, venture fund partners or Limited Partners providing the investment capital.  In embracing the situation it seemed to me, to surprisingly frequent nods from the audience attending, that we should celebrate the upside of the new down circumstance. 

It should never be encouraging to an entrepreneur that they have been turned down by, say 12 VC's but then had another 40 identified in which to speak and appeal for funds.  That is unhealthy and unproductive for all parties all around.  I argue that it is a better and ultimately more profitable circumstance that fewer funds with fewer partners and analysts (but more senior partners) talking with a smaller but more talented pool of entrepreneurs seeking funds is a better situation all around.

VC funding is not for everyone and once or twice a cycle it seems like everyone can get it. It's like when your brother-in-law the car mechanic starts dabbling in spec home construction or "flip" real estate you know the housing market will crash.  The discipline of fewer funds will improve the market for every one as the funded entrepreneurs will receive money from the most appropriate VC and receive the most attention possible from them to leverage each party's cash, sweat equity and intellectual contribution.

Oscar Jazdowski capably played ring leader at our forum and he ably challenged panelist and questioners alike. What I found is that early morning people really do get the worm - and the best advice.  Those 70 early risers walked away with, at least, some level of intellectual stimulation, a contact or two, lots of metrics and particular insight on how to be prepared for the best possible funding opportunity that they may deserve. 

Some learned, disappointingly, that VC funding was not for them or that they were wholly undeserving to receive funds. No one had ever told them that before.  While perhaps stung for a moment, they got to spend the rest of a sunny bright day reflecting and acting on how and what they should do to move forward  rather than waste precious time chasing VC dollars and delaying dreams that were unattainable.  They got liberation instead of money - and that may have been worth more that any millions of dollars they hoped to have received.  At least until the cycle turns again and the VC investing in this current economic trough provide great returns resulting in allocation increases by LPs.  Then we'll get back to the point where I'll have to get up again in a future decade and give the same talk.  I can handle it once every ten years or so.  Now if only we could have a forum that started at 10 PM?  I'll buy the last round.

Mark S. DiSalvo is the President and CEO of Sema4 Inc., dba Semaphore (http://www.sema4usa.com/), a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for six Private Equity and Venture Capital funds and advises General and Limited Partners around the world. Semaphore's corporate offices are in Boston with principal offices in New York and London.