While startups of all sizes are still in the market looking for funding and investors continue to scout for deals, closing is running into a big wall: on-site due diligence.
In a webinar last week, San Francisco-based law firm Morrison & Foerster highlighted site visits as a key stumbling block.
Marcia Ellis, a partner at the firm, pointed to a transaction for which the due diligence was slated to start on March 15.
“It’s a strange deal where due diligence is being done after the investment,” she said. “Now, the parties have realized that March 15 is just not a possible deadline, so they’ve had to delay.”
Under that deal, a retail-focused company needed funding “very quickly,” with a separate transaction that needed financing, she said.
“They didn’t have time to allow us – our clients – to do the due diligence in the beginning. Our clients agreed to invest a very large sum of money in this company without first doing the due diligence, but they have a very strong put right to the founder individually, who owns quite a number of assets that will allow them to get out if they’re not satisfied with the due diligence,” she said.
A put option gives the holder the right, but not the obligation, to sell assets at a fixed price.
The underlying assets are in China, and the investor was a Cayman fund, with a management company in Hong Kong, she said.
The law firm pointed to the retail sector as being extremely hard hit by the outbreak of the COVID-19 virus, with some companies facing an uncertain period of zero revenue. Ellis said some companies in the retail and education sectors – such as schools, which can’t collect tuition due to closures – are slated to potentially face bankruptcy if they are unable to get emergency financing from private equity funds or other parties.
Yemi Tepe, a partner at the firm who specialises in financing, said she’d been “extremely busy” renegotiating financing terms, including maturity dates, covenants and pricing.
Tepe said in some limited cases, lenders are lowering pricing. In other cases, rather than taking up more expensive financing, businesses facing “pretty grim” cash flow outlooks are getting “good terms” on bridge financing from funds and multinational corporates.
Others have pointed to the difficulties of closing deals without being able to make site visits.
Dr. Lim Xinhong, a director and analyst at Singapore-based venture capital (VC) firm Vickers Venture Partners, said investor appetite has “softened significantly” amid the virus outbreak.
“You can see entrepreneurs really still trying their best to raise money,” he told DealStreetAsia last week. “We’ve had the luxury problem of having to really interact with, I think, too many companies and making it very difficult for us to decide which to support.”
Lim said his firm was able to do a lot of due diligence remotely, citing globally distributed expertise and the use of conference calls.
“Of course, we have to do on-site visits to verify a lot of the claims. For the moment, we are, especially in regions that are severely affected, unable to do so,” he said. “But I think we’re able to get very far [on examining deals] without doing [site visits].”
Tong Hsien-Hui, head of venture investing at SGInnovate, a Singapore government-linked investor in deep tech, said startup founders have become “very, very open” to negotiate on any terms.
But on the investor side, making a decision has become more difficult, he said.
“A lot of my fellow VCs are facing the challenge of working remotely and not having access to their teammates for doing due diligence and due diligence sometimes involves physical visits to the startups or location and if the risk is too high, or it is deemed too difficult to do so, then people just won’t do it,” Tong said.
He added a lot of SGInnovate’s overseas deals are on hold because decision-makers can’t travel there for a final assessment.