The meteoric rise and collapse of Theranos is an object lesson in the value of audits. Well known public figures were duped into investing into an unproven and fatally flawed technology that turned to shit, taking a once high flier to a likely sojourn at Club Fed. During its time, Theranos never had an audit. Investors had no verifiable insight into the firm’s financials. Ergo they were betting on a founder who turned out to be a fraudster. An audit is not guaranteed to expose that but without an audit there is no chance that investors would be protected.
In the U.K., platforms like Crowdcube and Seedrs promise retail investors glamorous prospects but in the cases I’ve seen the extent of due diligence is…(sometimes) woefully inadequate.
Chief among the failings is a lack of audit supervision. Audits have a poor reputation for protection against fraud but for investors, they provide the first line of defence against overly eager founders who often have little idea of financial probity.
Why is this an issue for me? Put simply, I am an early investor in a plant based business that couples it’s pitch to EIS relief. That means my risk is at least partially mitigated by the U.K. government tax regime that allows me to claim an offset of up to 30% of my exposure. it means I can play in the investment casino with downside risk but at a price point I choose. And trust me, some of those bets have turned to shit.
Right now, the firm is in yet another crowdfunded round with about 1,000 existing investors already committed. The current raise target is pitched low at £500,000 but the longer term (and likely needed) goal is £1.25 million at a current valuation of £6 million. It’s not huge by any stretch but other factors make my point.
In the firm’s most recent round, there is no audit opinion to accompany its accounts and the extent to which risk exposure has been measured is, shall we say, flaccid. Some of the numbers make little sense and while management’s explanations are, on their face, reasonable, there is no independent testing to assess management’s overall financial competence.
In addition, the firm was classified as ‘hospitality’ and we all know how that’s gone during the pandemic. To its credit, the firm has survived and claims to be doing well at the EBITDA level in a limited post pandemic reporting period. On the other hand, the company’s historic financials prove the pandemic impact point only too well.
What’s worse is that the founder, whose heart is unquestionably in the right place and who has taken on a part time finance chief seemed blissfully unaware of the audit need or value in advance of a planned exit in the next 3-4 years.
Whether by way of listing, trade sale or PE acquisition, an audit will be part of the hygiene factors any serious investor will require yet it’s not part of the planned deck. The finance chief notes it would add cost but that is immaterial to the comfort factor it provides potential investors. In my view, a clean audit opinion could support the current raise price.
I’m a huge fan of this company and admire their progress despite the pandemic headwinds (and so no, I’m not going to name them.) But even given the juicy projections, I’m passing on this investment round because an audit isn’t in the plan both now nor into the future although the founder has indicated it is something they need to bear in mind.
What my downside gain? As an investor with pre-emotion rights and knowing the projections I’m looking at 30-40% gross based on current prices. Is that worth the risk? Probably and especially given the firm is in a hot sector. But, I want that audit now and absent such an opinion, even at this relatively small scale, I’m going to pass on the opportunity this time around.
Disclosure: according to records, I am one of the larger private investors although my total investment is low five digits.