The worldwide lockdowns, social distancing rules and travel restrictions to curb the Coronavirus have made thorough due diligence a lot more complicated. It has put more emphasis on digital processes.
“Digital due diligence was perhaps on the periphery prior to the pandemic,” James Prebble, director and co-founder of London-based digital consultancy Palladium, told Impact Investor in an interview.
Instead “financial, legal and commercial due diligence would be prioritised in terms of where the spend on advisers might go prior to an investment,” said Prebble, a course director at the British Private Equity & Venture Capital Association (BVCA) and a former specialist digital advisor to KPMG, Boxwood and ATOS.
Palladium provides private equity investors with digital business insights, in-depth market analysis and an assessment of a business’s digital capabilities. Its clients include Palatine, Bridges Fund Management and BGF, all of whom run impact funds.
“The change in focus to digital and technology-led diligence has been enormous,” Prebble said, adding that since the pandemic, Palladium’s digital business has grown 200%.
“If we don't understand the digital and technology competencies of these businesses at the start, we are already facing an uphill battle,” said Prebble.
Take an e-commerce business that has seen huge growth during the pandemic. “How sustainable is that acceleration? Have they grown alongside the market or are they outperforming the market? Investors want to understand that from a digital perspective,” said Prebble.
Digital due diligence ‘here to stay’
With an increasing number of impact funds looking at technology-led investments such as agritech companies, digital due diligence “is here to stay,” said Prebble.
”It's now a key component part. No investor is getting through the investment committee without being able to demonstrate that the business is on solid digital foundations. So it's not going away. It's a requirement to be able to demonstrate that the business has some digital or technology competency.”
On impact investments, Palladium looks at “the structure of the data being produced, how reliable that data is, how well managed and maintained that data is. That really gives the sense of the impact some of these businesses are actually having and whether or not they're delivering against their sustainability agendas,” said Prebble.
Palladium was recently asked by an impact fund to look at an agritech business.
“What they want to understand is how well-built these agritech platforms are, and how scalable,” said Prebble.
“But then they need to understand, OK, how does this product develop and how do I ensure I'm maintaining data integrity and development integrity prior to this investment. And of course, why would they? They are not in that space to understand it. But they're now looking at moving into more technology-led investments, they need to understand what's gone on within that.”
‘Underinvestment in people’
When asked what common mistakes funds are making when it comes to digital due diligence, Prebble said: “Underinvestment in people.”
Certainly in technology-led impact investing, Prebble said he is still seeing “a lot of key person reliance, so the spread of responsibility is perhaps not quite there because there are capability gaps, they can be quite light in terms of cross-company expertise. So I think underinvestment in digital and technology talent is one of the mistakes that gets made.”
Rogier Pieterse, managing director of Pymwymic, told Impact Investor the pandemic has led to the Dutch impact investing cooperative increasingly using digital tools, such as video conferencing, in its due diligence process.
"Normally, you would visit the company for a day or two and you would also go to the field to test their products,” said Pieterse. Because Pymwymic owns a regenerative farm where companies can pilot their products, it is still able to do its own product testing.
“So that still forms part of the due diligence that we can do, physically speaking,” said Pieterse. “But the team dynamics in particular have become a bigger leap of faith because of Covid. For example, interviewing a member of the management team you want to invest in on Teams or Zoom is not always easy.”
"We often invest in consortia with other investors,” said Pieterse. “Usually one of these investors has already had dealings with the management team of the company, so you bank on that a bit."
With the pandemic restricting on-site visits and in-person due diligence meetings, impact funds with local networks on the ground are at an advantage.
Take Amsterdam-based Goodwell Investments, Holland’s oldest impact investor which has provided over €150mn in funding to 35 inclusive businesses across Asia and Africa in the past fifteen years.
It has teams in Kenya, Nigeria, South Africa and the Netherlands. Just like Pymwymic, Goodwell switched to virtual due diligence fairly soon after the lockdowns were implemented last year.
Goodwell’s local teams would “literally be walking around Africa with webcams on site, so different parties could watch,” said Nico Blaauw, director of marketing at Goodwell Investments. Goodwell was able to make the switch to virtual due diligence so quickly because it had already built up “a relationship of trust” with its portfolio companies and investors, Blaauw noted.