The Importance of Technical DD & ESG Factors in Venture Investing

By Unnat Bak — Chief Strategy Officer @ TABS Score & Ashish Sharma — Business Analyst @ Frontline Strategy Funds

Why is Technical Due Diligence/Code Audit important when investing in a startup?

The founding members, advisors, board members, and even employees of the TABS team and the parent Frontline Strategy have a large cohort of seasoned venture investors that have conducted diligence on thousands of companies.

As potential investors, when we meet early-stage companies, often they tell us a similar story: they’ve already spent a lot of money developing a minimum viable product and now need cash for scalable sales efforts. No matter what the source of the capital is, things don’t work for them often as planned. Every time they try to introduce a new feature, it’s nightmarish. The code seems jumbled and complex, which few outsiders seem to understand in detail. Investors too are often clueless about the MVP so created from a technical point of view. Is there any way to make Capital work without it being spent on a sub-optimally written code that can’t be scaled up easily?

Yes, there is a way to gain a deeper understanding of a startup before investing one’s hard-earned money. The solution lies in a Technical Due Diligence (DD)/Code Audit.

But, what is Technical DD/Code Audit? And why did the team at TABS focus on creating a robust module that can conduct a strong Technical Due Diligence process in a fraction of the time and cost?

Due diligence is a process that involves an investigation, audit, or review to verify facts or information about a subject. Similarly, Technical Due Diligence/Code Audit is a process to examine and assess the core technology, product design, and functions of a business before investing in it.

Why is Technical DD important?

The purpose of a Technical DD is to provide a comprehensive report on the viability of the software or product, to ensure that it is high-quality, manageable, scalable, and secure. The main reasons the investors are interested in code audit/technical due diligence may vary but the end goals are aimed at determining the following:

  • What is the actual worth of the business?
  • What kind of sales can the business generate?
  • Is the startup equipped to deliver on all of its promises and its potential from a technology standpoint?
  • Scalability check: is the code apt for additional features and external integrations when and as needed?
  • Are there any existing security vulnerabilities or functional gaps, with a potential for malicious hacking or loss of trade secrets/data?

Each hour spent in code audit can save many more hours in maintenance. The emphasis is on the fact that if threats that could be detrimental to the product are identified at the early stage, time and money, that would otherwise be spent on fixing the security threats, can be deployed for more productive purposes.

Technical Due Diligence provides the opportunity to identify malicious code and application backdoors during the audit which can help the business fix the bugs in time, making it more secure. If code audit is conducted systematically, the startup can accurately define scalability estimations and provide better maintenance options to improve the efficiency of the product.

The risk of security breaches, vulnerabilities, leak of personal data, or even fraud increases exponentially if the codebase is weak and the startup would be the one to bear the disastrous consequences that could follow.

TABS’ Technical Due Diligence & Code Audit Module Covers:

  • Automated testing, which helps to dig deeper and provides a more efficient code analysis report at a faster and cheaper rate with a list of appropriate remedies.
  • Checking front-end and back-end code quality to ensure a user-friendly experience and test the stability of the code, and its capability to handle any security threat.
  • A thorough infrastructure review to ensure best practices are adopted for hardware, software, and processes with documented procedures.
  • Periodic audits to have more opportunities to identify any potentially harmful and sub-optimal issues and implement updated security measures.

Technical Due Diligence/Code Audit can be a time and cost-intensive process though it comes with the risk of exposing the code and IP to external agencies unless the process is automated. A secure codebase ensures a solid foundation for the growth of any business and greater potential returns for the investor. A properly executed technical due diligence and code audit can help assess the company’s future earnings potential as well as the risks to the technicals underpinning the business strategy. The audit will certainly highlight details that warrant further investigation but the above-mentioned checklist will prevent investors from overlooking information that is critical to their decision.

Similarly, ESG has become an increasingly important aspect to consider when conducting diligence on a potential investment.

The Importance of an ESG Audit when Investing in a Startup

ESG was previously known as ethical investing, then transitioned into socially responsible investing, or SRI, and then back to ESG. There is something about the ESG narrative that is appealing, and that people are drawn to. To generate a positive return on capital deployed while doing good is a powerful concept.

ESG Audit is not just beneficial for every up-and-coming start-up company — it’s practically required at this time. The TABS Suite has incorporated an ESG diligence module that can be added to the assessments being conducted on your potential investments.

ESG Recap: A Quick-Refresher

ESG investing refers to a set of investment strategies aimed at generating financial returns while also addressing environmental, socio-economic, and governance concerns.

  • Environmental Concerns: ESG investment aims to address environmental concerns such as carbon emissions, ecosystems, and human health. Climate change, renewable energy, and pollution prevention are all given top priority.
  • Social Issues: Here we address issues related to inclusion, diversity, working conditions, and workplace health measures. ESG investing boosts employee productivity as well as customer brand awareness and loyalty.
  • Governance: As a result of globalization and social media, companies’ behavior and policies are being examined more closely than ever before. The ESG Governance approach emphasizes subjects such as board responsibility and diversity, shareholder protection, information reporting, and disclosure.

What are the benefits of ESG audit for start-ups?

Agendas of many large firms today are constantly dominated by environmental, social, and governance issues and early-stage start-ups need to embrace similar standards to ensure their long-term sustainability and value creation.

Consider some of the advantages of ESG audit for start-ups:

Enhanced Investor-base

ESG is becoming increasingly important to investors when evaluating start-ups. ESG-implementing start-ups are regarded as relatively safer businesses since they are less likely to face social reprisals, civil lawsuits, or state sanctions, making it attractive to invest in green businesses.

Recruiting Talent

When it comes to attracting top talent around the world, progressive ESG policies are a big draw. Millennials prefer to work for organizations that adhere to and implement ESG initiatives including diversity, inclusion, sustainability, and other such criteria.

A better public image

Socially responsible businesses attract more investors and get more trust and respect than those that do not implement effective ESG practices. With the current threat of climate change and resource depletion gaining increased mind space of consumers, employees and investors alike, businesses that do not adhere to ESG practices risk the danger of diminished support from society as well as investors.

How ESG Audit Aids Investors While Investing In A Startup

In recent years, investors have placed a large emphasis on ESG integration with the core business strategy. Times have evolved and investors are becoming more vocal in these areas and addressing ESG enabled investments with more attention and discipline than before.

So, the question arises — why does an ESG Audit attract investors’ interest?

ESG Audit helps investors with three factors that affect their decision-making, these essential factors are as follows:

  • Transparency: Investors want clarity on integrating the business model and ESG considerations of the firm. The more transparency a start-up provides its investors, the larger are its chances of winning over the investors’ trust.
  • Consistency: Investors view start-ups that integrate ESG practices as more credible as it demonstrates start-up’s consistency in implementing best practices in their business model.
  • Assurance: ESG Audit ensures that the start-up is ready to take responsibility while also functioning in a manner that is socially and environmentally beneficial.

The Constantly Evolving AI Powering TABS’ New ESG Module Covers the Following Topics, and More:

  • Does the company monitor and annually review the business policies and plans affecting the environment?
  • Does the company communicate the importance of environmental issues to the employees and embedding environmental responsibility?
  • Does the company have policies and procedures in place to protect company-wide data and remedial action plans in case of a security breach?
  • Does the company have practices in place to promote equality in the workplace?
  • Does the company have zero tolerance for all forms of bribery and corruption?
  • Is the Company’s board an independent entity, capable of resolving issues and conflicts of interest without bias?

Investors desire to know how their firms treat the employees, the procedures in place to ensure responsible investing, and methods being used to promote sustainability efforts and sustainable relationships with vendors.

An ESG Due Diligence helps in determining the current position of the business on issues of social, environmental, and governance matters taking into account the business goals and risks. ESG Due Diligence can help formulate effective ESG integration plans which can be a deciding factor for a potential investment in a startup, risk mitigation, and creation of long-term value.

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The TABS Suite is the leading DaaS (Diligence-as-a-Service) platform augmenting your existing diligence process in a fraction of the time & cost. TABS provides a comprehensive, holistic, and in-depth qualitative & quantitative evaluation of a venture, regardless of the stage (Pre-Seed to a Series D to Private Equity). www.tabsscore.com

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