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Eugene Hill and The 5 MS: Executing The Due Diligence Plan: Lisa Cooke
Eugene Hill and The 5 MS: Executing The Due Diligence Plan: Lisa Cooke
Theres
a huge no factor, for a whole
host of reasons, Hill says.
term sheets and invested in one deal.
the Five
Ms: Market, Management, Method,
Money, and Metrics.
philosophy involves what he calls
Fine-Toothed Comb
Hill always conducts background checks for
things like criminal activities or other icky
stuff; sometimes, however, the check turns out
to be unnecessary. Merely suggesting a
background check can open the confessional
floodgates. When we ask, Is there anything
else we need to know? the amount of stuff we
get is amazing, and horrifying, Hill says. The
most frequent falsification involves education
credentials. More seriously, in regulated
industries people have not disclosed past
criminal activities in their applications while
building the business, but in falsifying an
application to a regulator, that person has
already committed a crime.
Hill also has lawyers look over the paperwork
the company has amassed to date, looking for
fatal flaws. Many cash-poor startups have to
scrimp on legal advice, and things do not get
buttoned upthe IP may not be under control,
the companys books may not be audited, or
stock may have been sold and not accounted for
in ownership documents. Decimal points may be
misplaced in contracts; verbal agreements are
not notated.
Ive seen major gaps between what companies
thought their financials were and what we saw
when we came in with pros. None of this is a
problem until its a problem, [and] then its a huge
problem.
Face-to-Face Facts
Even management all-stars can have skeletons in
the closet. Hill likes to meet executives in both
M3: Method
If an entrepreneurial company can make it past
Hills first two rounds of questions, it is off to a
good start. However, the business methodology
can be a tricky path to navigate.
Drilling Down on the Value Proposition
Hill examines the companys value proposition.
In other words, what is the business model? Is it
a product, is it a service, or is it a mix of both?
Does the product save time, money, or both? Will
it succeed by increasing revenues or by slashing
costs? Will it beat competitors through higher
quality, by being quicker to market, or by being
a product revolution?
You need to know if its better-fastercheaper or a Brave New World6 equation.
5 See, e.g., Geoffrey H. Smart, The Art and Science of Human Capital
Valuation: Smart Assessment, Smarter Performance, Big Speak
Consulting white paper, 1998, http://www.bigspeak.com/consulting/
white-papers/Geoff-Smart_Horizontal-Human-Capita-Valuation.pdf;
Geoffrey H. Smart, Management Assessment Methods in Venture
Capital: Toward a Theory of Human Capital Valuation, dissertation,
Claremont Graduate University, 1998, http://www.ghsmart.com/
media/press/methods_in_venture_capital.pdf.
6 Hill uses this term frequently to refer to a certain type of
groundbreaking business entity. The phrase originates with the 1932
speculative fiction classic Brave New World by Aldous Huxley (New
York: Harper Perennial Modern Classics, 2006).
Better-faster-cheaper is good.
You have a reference point that
you can verify because you know
a ton about the market. Brave
New World is tough because the
market doesnt exist yet, Hill says.
With Brave New World, even
with the best engineering teams,
companies often are at the limits
of material science. For example, as a
startup Intel had huge waste rates before they
figured out how to do integrated circuits
properly, Hill says. They had to invent clean
rooms and large-scale integration. It meant
building something for scale, and meeting
certain specifications; it also meant investing a
lot of money, well beyond the resources of most
venture capitalists.
Compare Intel with Cypress Semiconductor, a
company that came in later but was building
highly specialized chips sold mainly into the
defense sector. Cypress was able to carve out a
very nice niche building high-performance chips
that did not need to be produced in high
quantity, because they could sell them at a
premium for their superior performance. Their
plan did not require a Brave New World solution.
Lisa Cooke
A professional journalist and syndicated
columnist for the early part of her career, Lisa
has been a writer and content strategist for San
Francisco and Silicon Valley corporations and
startups for the last fifteen years. Her clients
have included Twitter, Adobe, Shutterfly,
Genentech, Zynga, Time Warner Cable, and the
Department of Defense.
The Market
The Money
The Management
The Metrics
The Method
Figure 2. Due diligence questions from Eugene Hills Five Ms. Image by Kauffman Fellows Press.