By Dana Ambrosini, Pg. C1
NEW HAVEN – Entrepreneurs with skeletons in their closets should be upfront about them when looking for venture capital, a due diligence expert advises.
An entrepreneur might be cringing over a $50,000 lawsuit against his firm, but that’s peanuts to a company considering a $2 million investment, said Matthew J. Cherry, a business intelligence specialist who spoke at a recent ACE-Net seminar at the New Haven Lawn Club.
ACE-Net is a nonprofit agency that connects entrepreneurs with investors interested in funding a business in its early stages.
“They’re upset that they have to find out about negative information at an inappropriate time,” said Cherry, president of Intelex.
The Greenwich-based firm performs due diligence background checks on firms and their management teams for investment firms and venture capital investors.
Investors shouldn’t be surprised to find problems in the backgrounds of entrepreneurs they may support, Cherry said. Entrepreneurs are risk-takers by nature and many have lived check-to-check in honest attempts to keep their fledgling businesses alive, Cherry said. “They live life a little on the edge”, Cherry said.
However, at some point, those problems can hurt the investor as well, Cherry said. In nearly half of the cases it takes, Intelex finds some important information that – while not necessarily a deal breaker – is something the investor should know before signing on the dotted line. Only some two to five percent of the cases involve serious fraud, Cherry said.
A more basic kind of due diligence weeds out most companies long before you look for criminal records, said Manny Ratafia, an angel investor from Woodbridge who invests in startup companies.
A group of doctors contacted Intelex to check out a venture they were considering investing in the construction of a resort on a tropical island. Intelex found the proposal was a scam. The “island” was really a tiny, remote tract of land, no larger than a football field, off the coast of South America. Most of the site was under water.
“You want to know how well-suited this person is to run your company,” Ratafia said. If the candidate and business seem stellar enough to consider backing, then you check into lawsuits, arrests and other potential problems, Ratafia said.
Sometimes an intensive background check into lawsuits, fines and work history can reveal some startling realities about a would-be partner.
Cherry used an example of an unidentified technology company that appeared to be a sound deal at first glance. But a closer look revealed that the charismatic entrepreneur had numerous outstanding debts, lawsuits and government fines for failing to pay his creditors – even when he could easily afford to do so. “It’s my money, mine” was the mentality, Cherry said.
Intelex’s client opted out of the deal, although a competing investment firm (unaware of his background) took it on.
Sometimes a bad reputation alone can be a deal-breaker, Cherry said. Intelex warned one client that an overseas businessman they were hiring to represent their firm had a bad reputation – although he was on the up and up. The firm hired him but ultimately had to let him go because clients would not deal with him.
Cherry advised investors to look for red flags. Conflicts of interest, liabilities, regulatory actions or a good deal of pending litigations can signal a problem, Cherry said.
“Do they indicate a pattern of behavior?” he said, investors should ask themselves.