When it comes to investments of any kind, due diligence is essential for both issuers and investors alike. Do so what exactly is due diligence?
Due diligence is ensuring that a potential investment comes with the accurate disclosure of all offering details. The Securities Act of 1933, a result of the stock market crash years earlier, introduced due diligence as a common practice. The purpose of the act was to create transparency into the financial statements of companies and protect investors from fraud. While the SEC requires the information provided to be accurate, it does not make any guarantees to its accuracy. However, the Securities Act of 1933 for the first time allowed investors to make informed decisions regarding their investments.
In the process of investing, investors should review all information available to them. Investors should ask questions such as:
- Company Business Plans: What are the issuer’s current and future plans? Do their projections seem reasonable given their current financial reports?
- Company Management: Who are the company’s officers, founders, and board members? What is their previous experience in business and have they had success? Does the management team pass a Bad Actors check?
- Products/Services: What does the company offer? Is it something that you would use or does there seem to be a wide appeal for the product or service in the market?
- Documentation: Is the company’s bylines, articles of incorporation, meeting minutes, and other related documents available to review?
- Revenue: What does the company’s revenue look like? Does it make sense considering the demand for their products? What do revenue projections look like?
- Debt: Does the company have debt? Is it comparable to other companies in the industry?
- Competition: What does the company’s competition look like and how do they plan to deal with it? Has the company properly protected intellectual property through trademarks, patents, copyrights, etc.?
- Funding: Why is the company raising funding and what are the plans for the money raised?
While these are important questions to ask, there are other factors that investors should think about. Investors should consider whether they are financially able to take on the risk of investment. While investing in private companies can lead to a huge return, success is not guaranteed. Investors should ask themselves if they would be able to afford to lose their investment or not immediately being able to make a profit. They should also ensure that they are qualified to invest. If they are a non-accredited investor, have they already made investments that could alter the amount they can invest?
Issuers should make sure that all information investors need to make an educated decision to invest is adequately provided. They do not want to risk potential lawsuits down the road for failing to disclose certain information. Issuers can ensure that they are meeting all due diligence requirements by using a broker-dealer as an intermediary for their investment.