The short story is that a prominent start up financial services firm allegedly faked their audits and raised about $90MM in funding from VC firms over a couple of years:
Canopy Financial Accused Of Serious Financial Fraud, Investors Burned

Canopy Financial Turns Into Sad, Comical Game Of Hot Potato

As an active investor, entrepreneur involved in fund-raising and co-founder and officer of a financial auditing firm, this kind of story just makes me cringe. Leaving the validity of these accusations aside, running a good due diligence checklist is critical.

A lot of commentators have suggested ways that this situation could have been avoided.

Here’s a slightly better list:

1) Several people have suggested that GGV Capital and the rest should have contacted KPMG prior to writing checks worth $60MM. Umm… Yes. That should have been part of any basic due diligence list.

2) Look at the books. Meet with the controller and look at the darn books. Ask a few questions and look up the answers with the controller. That shouldn’t be difficult. If it is, ask yourself why.

3) Talk to some vendors. What was the volume of sales to the subject company? Were the bills paid on time? What are the outstanding receivables? Most vendor contracts of any significant volume provide for an audit. You don’t need to do an audit, but you can certainly request a comprehensive statement of account from the vendor. That can be very telling.

4) Talk to some friendly clients. (If they don’t have any friendly clients willing to take an on-site visit, think very hard about why this might be!) What was the volume of business with the subject company? You don’t need to ask sales questions of the client, but you may learn a lot from this call anyway.

5) Talk to some salespeople and/or marketing people at the company. Where are they getting sales? What do their prospect lists look like? What does the pipeline look like? What percentage do they convert? Is there any possible way that the business is realistic and sustainable? What levers can they pull to create growth? All of those questions should be asked prior to getting into due diligence.

6) Do an on-site visit just to look at operations. If it is a tech company, where are their developers, support people and servers? How do they run the thing? It may all be “in the cloud,” – which is great – but the last time I checked, you still have to have butts in seats somewhere on the planet to provide software engineering and support.

7) Does the company have inventory? If so, take the time to check it out. Send somebody to the warehouse. Take a digital camera. (This often doesn’t happen, which is startling.)

This is just the short list, which would have helped this particular investment situation. Our actual due diligence checklist is a lot longer, starts with the legal and financial review and then digs into things like IT strategy, hiring strategy and systems architecture, if appropriate.

How much should the short due diligence list cost? Not much. Maybe $15K to $25K – which ain’t much when you’re writing a $60MM check.

If you’re considering a serious investment, please take the time to contact a firm like Black Mesa Consulting, or somebody who runs a decent due diligence checklist.

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Kraettli Lawrence Epperson

Managing Director at JumpPhase Ventures

This blog is dedicated to providing advice, tools and encouragement from one entrepreneur to another. I want to keep this practical and accessible for the new entrepreneur while also providing enough sophistication and depth to prove useful to the successful serial entrepreneur. My target rests somewhere between the garage and the board room, where the work gets done and the hockey stick emerges.

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