Below is the “Tip of the Week” transcript from the Podcast Episode 19: Due Diligence (Imran Ahmad)
Today Imran talked about how diligence can really increase a portfolio’s returns b/c it helps identify major risks. Maybe diligence will not increase your startups opportunity for success, but it may change the portfolio of startups that you invest in.
The problem that I’ve heard from angels and superangels is that it is a long process that takes a lot of time. Not every startup investor has the time or has a process in place to execute diligence efficiently. So, I wanted to include some resources that can help make one more efficient at executing the process or identify ways to democratize and/or delegate.
The first resource that is worth reviewing is the…
They start off by discussing sources of risk by various categories including:
* Market Demand
* Management Capability
* Capital Requirements
And each category can be ascribed a risk percentage. In their example, there are seven categories and they assign 90% likelihood for success to each, which assumes a 10% chance of failure. So, when all seven of these 90% figures are aggregated, the collective success probability is 48%. As they show, if even one of these categories moves down from 90% to 50%, then the collective success is reduced to 27%.
From a theoretical standpoint, this shows that the layered risks or red flags from multiple evaluation categories can significantly decrease the likelihood of a successful outcome.
The second resource I wanted to include is a questionnaire that allows one to walk-through and answer the majority of diligence items. It doesn’t differ significantly from most other checklists, but the question format maybe easier for an investor and founder to talk through… and may allow the startup to take the driver’s seat when producing these items.
Then, the final resource I’ve included is an actual due diligence checklist from the angel resource institute. It clearly separates out all of the categories of information and the specific items required in each. For those coordinating or quarterbacking a diligence process, it makes for a nice dashboard for delegating out responsibility and tracking status.
Not every investor is willing to do diligence or has the time and/or resources available to conduct diligence. In this case, if they want to invest, there often must be a lead investor willing to complete the diligence process. Or, in many cases, angels will join an angel group so that they can benefit from many member’s efforts and their expertise.
I’m also aware that there are now some top MBA programs that have formed groups to complete diligence for others. From what I have learned, they often conduct these diligence activities for free, in exchange for the experience of doing it. So, if you have strong deal-flow, but are in need of MBA-level analyst support for your diligence, I’d encourage you to reach out to these student groups at Harvard, Michigan-Ross, Dartmouth-Tuck, and Virginia-Darden. There may be others, but those are the schools that I am aware of.
So, while some may see diligence as a long and arduous process, it is critical to execute and protects one’s investments. Investors can join an angel group, utilize the resources mentioned and/or find groups to assist with diligence in order to reduce the burden and realize the benefit.