Six months following from the implementation of the Fifth Money Laundering Directive, Shieldpay’s Compliance team take a look at an important yet largely unconsidered area of dealing with financial crime, when firms need to raise funds for investment. Do you know who your investors are? Where their funds are coming from? Or even whether they have an influence on your business that may actually cause harm?
The ever-growing threat of money laundering, especially during unprecedented times following the COVID-19 pandemic, has meant that for many firms seeking investment in order to survive, grow and innovate has raised the profile on the importance of effective investor due diligence.
Finding an investor – particularly in the current climate - may seem a challenge, however you should always take stock before you grab the interest with both hands. Sadly, just because an investor is offering you a lifeline, it doesn’t necessarily translate into success. An ill-thought through and poorly researched investment prospect could be detrimental to your business, so to ensure that your business picks the right opportunity, it’s essential to thoroughly do your due diligence. This will indeed be essential to your business’ success, as investors could and should promote the value and best interests of the business!
Before we go on to highlight some of the themes to look out for when fundraising, let’s reflect on what due diligence means.
In short, due diligence is a process that verifies and validates statements and views about a business. By conducting an investigation, audit or review of that business or investor, the process is designed to reduce the risks of making or receiving an investment. Typically, due diligence requires an examination of the financials and business plan, however it can in reality require a lot of digging. The objective is to unearth as much information as possible to be comfortable with the opportunity prior to advancing discussions. This can include the culture of the firm, compliance controls and processes, key business risks and also who is behind the team.
So, what are the key themes to look for when conducting effective due diligence on your potential investors?
Capital raising: Know your investor
It’s not good enough to just run your standard due diligence processes on potential investors as you would for your customer base. It’s vital to get under the skin of your potential investor to really understand their motivations, experience, previous track record and most importantly what value they can bring to you as a business apart from the obvious…money!
Most backers will understand that knowing your investor is a significant risk to your business and they will understand the need to conduct due diligence on them. It also gives them the confidence that you are doing the homework and, in most cases, they are happy to assist you. Should an investor be annoyed that you are doing your homework on them, it is worth considering whether they are deliberately hiding something from you. In this instance, you should be very wary about the investment opportunity.
It is crucial to really understand what an investment can bring to the table. Do they have the relevant experience to kick your business off? Will they work harmoniously with the Board of the business and the other investors? Do they genuinely want to join you on this exciting journey? Indeed, you may not want to work with an investor who has negative media coverage or a history of shady business dealings.
While there are no hard and fast rules on knowing your investor, it’s important to understand their strengths and weaknesses so you can form a holistic view of them and make a much more informed decision, resulting in receiving more than just the investment.
Fundraising round completed, now show me the money!
You get the picture now: it’s imperative to understand who’s interested in investing in your business. But how about the proposed investment structure? Is the investor an individual with knowledge and sophistication, a complex corporate structure with some links to tax havens, or even government body? Knowing how the investment is structured and where the money is coming from is essential to know that you are taking legitimate funds.
Different investment structures present a different level of risk to your business and it is vital to know their financial background.
Driven by anti-money laundering obligations, businesses receiving investment should always try to understand the investors’ finances – more specifically – their source of wealth and source of funds. Sometimes these terms are used interchangeably but they are, indeed, very different.
A business receiving investment should drill down on understanding how the investor is able to afford to invest in them. Is it because they are a sovereign wealth fund backed by a wealthy nation? Are they an ‘angel investor’ who has a well-publicised track record of successful investments? Are they a family office managing the wealth and funds of an extremely high net worth family? Additionally, understanding an investors’ source of funds (i.e. how the investment will be made) is equally important for a business receiving monies, as it frames the level of risk. For example, you may be more comfortable receiving money from a UK individual’s UK bank account rather than a complex corporate structure based in a volatile jurisdiction that brings the investment in to the higher risk domain.
Taking the above into consideration is vital for a business as it enables them to frame the level of risk that the investor presents.
Trust your gut and look at the facts!
In these unprecedented times, many businesses are in desperate need of a financial lifeline. While it may seem an easy option to ignore the investor’s motives, you should not cut corners in thoroughly understanding their intentions for investment. It might not be always so clear cut, however it is vital for you and your organisation to develop a sense of whether the investor is good for business and can help build a good relationship.
Given the changes in the economic climate and the impact of recessions or even pandemics, businesses crying out for investment can be susceptible to the risk of bribery. Vulnerable businesses present an opportunity for investors with deep pockets looking to advance their own agenda by using their investment as a bargaining chip if their demands cannot be satisfied, e.g. threat of withdrawing funding if certain requests are not met. It’s important to be aware of these situations and not fall foul of this.
Whilst it’s difficult to remain focused when raising funds, knowing who your investor is, where the funds are coming from and how they can help you with your business remains core to ensuring the success of your fundraise.