What is Due Diligence?A measure of prudence, responsibility, and diligence is expected from, and ordinarily exercised by, a reasonable and prudent person under given circumstances. Thus in operating an entity, founding a startup, a potential investor will gather necessary information on actual or potential risks involved in the investment opportunity. It is the duty of each party to confirm each other’s expectations and understandings, and to independently verify the abilities of the other to fulfill the conditions and requirements of the agreement.
Are you prepared to overcome an investor’s expectations? Considering that their expectations start and end with a return on their investment, what are some of the most common red flags that give potential investors pause?
Let’s a take a stab…
- Are the founders investing their own money in the venture? If not, why would anyone else?
- Are there an exceptional number of investors and/or industry inexperienced investors who have a sizable share? That can signal that raising earlier funding was particularly difficult for some reason or that there are investors involved who might burden the focus of the venture.
- Mistaking customer validation for market validation. Potential and existing customers DO NOT validate that you can achieve and maintain a share of the market. Do you have market validation?
- Gaps in the team – at least, essentially, three areas of focus: resources, building, and the market. As I’ve put before, the Butcher, the Baker, and the Candlestick Maker.
- “There is no competition” or “this is a unique idea” – sure it is.
- Lacking basic marketing/KPI oriented elements: capable site, Analytics, appropriate social media, some Adwords (or otherwise) capably tested, etc.
- Clearly inexperienced Go to Market plan. References to areas of focus being broad or generic and not distinctly applicable. Such as stressing: SEO, Content Marketing, PR/Press Release, Sales – that’s not a plan; that’s standard operating procedure for any organization
- Narrow focus in a broad market – only having partners/traction in one city, only being iOS for a mobile, only knowing one target when others are clearly applicable, etc.
- Excessive debt and/or stated intention to get the founders paid
- Early investors having no further interest. Even if only so as to make the right connections and provide experience/advise to further success, one can expect that anyone invested in the business continues to be so, unless something is wrong.
- Sole proprietorship or family focused founding / executive team. Investors seek exits – sole proprietors and families tend to keep a business in perpetuity.
- Suggesting unrealistic growth or projections. Likewise, unrealistic valuations. YOU WILL NOT GROW UP AND TO THE RIGHT.
- Neither a Board of Advisors nor Directors, equity allocated, involved. Your team is not limited to your employees.
- Incomplete financials
- Controlling or opaque founders. Can we look into everything? Do we know all the other investors? Is the team open to change? Loosely related things such as major foreign investors – whom aren’t necessarily unknown/silent but have different circumstances/considerations that may factor in
- IP or ownership issues. Likewise but contrary, expecting VCs sign NDAs
- Highly regulated markets or industries potentially so. Might the industry cause a problem and if so, are you aware of that possibility and have you addressed the challenge?
An exhaustive list? By no means! But consider as you endeavor that a potential investor will conduct due diligence and the process starts even before you have a conversation with them. Working to overcome the causes for concern might be a better approach to getting funded than perfecting your pitch.