Tuesday, October 22, 2013

Early Stage Investor Due Diligence: A High Level Take on What Matters

As I described in my recent post, Due Diligence - The Philosophy Part, I  recently gave a talk to Empire Angels on the subject of early stage investor due diligence, courtesy of Graham Gullans and Christina Bechhold. I followed up with another at The Hatchery on the invitation of Yao Huang. (And will be on a panel focused on this topic next month hosted by Angela Lee for 37 Angels.)

I spent a fair amount of time at the two past sessions framing the issue of "what to do" rather than getting straight into a "traditional" check list of steps to things "to do". My key line was:

"You need to recognize who is taking the real risk here and treat them [the entrepreneurs] with commensurate respect."

High Level Process Thoughts for Investors

Respect, and to be honest good use of your own time, translate into these three high level process guidelines:

1) Be sensitive to the context and the risks the entrepreneurs are taking and protect their time
- What can you do via desk research, talking to 3rd parties, not to them!?
- Don’t keep going back again and again for stuff. Have a few focused meetings, know what you want, and keep it to that
- Be aware that there is an 80:20 rule in most things … you will likely get 80% of the answer from 20% of the due diligence effort. Gathering the remaining 20% of the info but taking a lot more time ... will likely not change your answer!

2) Focus on the key issues for the given company

- What the biggest risks? 
- Biggest opportunities? 
ie Don't get lost in the weeds.

3) Try and set a deadline and stick to it
In the end know that this is decision making under extreme uncertainty. You need to make an informed but largely gut decision. For example Charlie O'Donnell recently spoke to the fact that he makes a decision in three weeks.

Getting to the detail: The Big Three, Then Three more ...

I break the due diligence to dos into what I called the three big categories and then three more. However there are many different approaches so what follows is just a personal perspective. By way of example Brian Cohen (read more at "What Every Angel Investor Wants You to Know") separates his "do diligence" into what he calls traditional build a better mousetrap and gee wiz "lottery" plays. He focuses on identifying viable innovation and disruption. And he says his "spidey sense" is key for lottery play. i.e. gut feel on steroids!

Anyway, back to my three own plus three more. These are:

The Big Three

1) The people

2) The product (or service)

3) The market & customers

Then Three More

1) Financials – which might surprise you but I will explain in due course

2) The Exit

3) Intellectual Property (IP)
I will dive into detail on all of these in my next post.