Understanding Due Diligence—and Why It’s So Important for Impact Investors

By Eva Yazhari

Due diligence is an essential component of the investment process. In essence, it allows you to take a deep look at whether or not a company is worthy of your capital. As Nicholas Java, director of diligence at Beyond Capital Fund says, due diligence is “the pipeline process with which we consider a business, from initial sourcing to the time we write the check.”

As critical as due diligence is for traditional investing, at Beyond Capital Fund, our first venture fund, we argue that impact investors have an even higher duty to conduct a comprehensive investigation of a company. That is because there is a social or environmental impact at stake. Impact investors are not only allocating resources to businesses with the most viable financial potential. They are moving capital toward the business with the most feasible market-based solution to a serious social or environmental problem that also illustrates financial potential. When an innovative entrepreneur builds a company to solve for good, it is the investor’s responsibility to peel back the layers of the endeavor to ensure its foundation is strong and viable to be able to do the greatest good.

Thorough due diligence can be a lengthy process. But the rewards often beget more rewards. I have found due diligence unlocks a well of learnings and ideas, for both the entrepreneur and investor. Due diligence can lead to lower risk later on in the investment process, including structural risk to the nascent company’s capitalization table and its early-stage investors. It can also ensure a strong, sustainable relationship between investor and entrepreneur, one established on transparency, trust, and respect. These elements go a long way for anyone collaborating on a shared mission to better the world.

Due Diligence: A Roadmap

In considering due diligence for impact investments, I have found there to be tension at times. Some early-stage investors are hesitant to get too data-driven about vetting opportunities. They also may be reticent to ask too much of the entrepreneurs that are striving to better the world. On the flip side, some entrepreneurs may not understand the benefits that due diligence can unlock and therefore feel it is a grand waste of time.

As a mission-driven investor, I believe the more collaborative and transparent the process, the more efficient and beneficial it is. So that begs the questions: Where do you begin? As an impact investor, what is the best way to conduct a thorough analysis and evaluate the proper quantitative and qualitative data?

The answer to this varies investor to investor, but I will shed light on the process we have created at Beyond Capital. Comprising six essential phases, our due diligence process is methodical and rather meticulous, but it allows us to consider all of the nuances and therefore all of the potential of the more than 200 businesses we consider each year.

It all starts with the sourcing. At Beyond Capital Fund we now source most of our opportunities from co-investors that we’ve had the opportunity to invest alongside in previous rounds, as well as through incubators that are either run by non-profits or through universities that sponsor social enterprise incubators.

After sourcing, we then get into the “show and tell” part of the due diligence process. This is where we get a bit more granular, because as we introduce a business into the pipeline, we take a closer look at potential business model concerns and vet any that may not be a fit. From there, we move forward with businesses that meet our criteria at Beyond Capital, which include (but is not limited to) commercial viability, impact mandates, scalability, and a developed and versatile management team.   

We consistently ask questions, such as: What is the problem and what is the solution? What stage is the business in? What is its funding source thus far? This brings us to the next chapter of the process, which is an open team discussion. Here we talk about any reservations or potential issues. We cover the level of detail brought to the business, its stats, when it was founded, how much capital it has raised to date, and any revenue information. Because many of these companies are nascent, this process can unveil a lot of imperfect information. Therefore, we aim for about an 80 percent solution in regard to whether or not we will move forward.

From there, we enter the debrief analysis stage. This is where we dive into the details, from looking at the impact metrics to measuring customer acquisition costs and auditing company financials. We come at it from a business perspective and then consider the impact. We ask rigorous questions of the entrepreneur, which allows for clarification, deeper analysis of the company overall, and greater communication.

At Beyond Capital, we utilize a 6M framework to help us efficiently vet companies. This framework includes six critical pillars. Those are: market, model, metrics, milestones, and management. These act as mandates, or barometers, to help us ensure we have covered every nuance of a business. A common part of the 6M process includes a site visit, which allows us physically to verify that the company’s entire ecosystem is on par with what it states on paper. A site visit allows for another impression to be made on the management and staff, the morale and enthusiasm of the team, and the ethos of the company. (We are lucky to have already met with many businesses over the past 9 months, lessening the challenge with travel during COVID-19.)

Impact management is present throughout our due diligence. When we evaluate a business’s intention to generate impact, we ask whether the product or service the company is offering is deemed a necessity to its stakeholders (customers, employees, the environment, local community, etc.). We also ask whether the product or service is adding value or extracting value from its stakeholders, two questions outlined in Morgan Simon’s Real Impact. Because impact investing is anchored in sustainability and long-term value creation, we ask if the company is committed to a market-based solution, and if  there is a commitment to measure social, environmental, or governance impact for the long-term. Finally, we think through what unintended consequences could result from the investment. A friend and long-time impact investor once told me a story of funding a cleft palate surgery in Latin America, only to realize the patient died of an infection later due to the lacking presence of medical services in the village. 

Ultimately, this process brings us to the point of greenlighting a potential investment in a company. Once we agree to move forward with an investment, we present the high points about the company—which include specific information on the business model and 6M factors—to the Beyond Capital board. We encourage you to think through how these steps can be applied to other investments with double or triple-bottom lines that you are considering.

A Worthwhile Pursuit

These stages can take time—weeks or months—and they vary company to company. It is important to continuously understand that while going through your due diligence process, a company also may be going through others. At Beyond Capital, some investments—from initial consideration to investment—have taken six months, others only a few. With that said, given the depth of information requested and provided, a generosity of time is often necessary to result in a beneficial and impactful investment decision.

It is for these reasons that the key to success in impact investing is found in the thoroughness of the investor’s due diligence— for the sake of their portfolio, the longevity of the company, the benefit of future investors, and the world at large.

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