Due Diligence Is A Two-Way Street

Bill Payne , Angel Investor , Frontier Angel Fund

21 Mar 2013

Investors regularly confuse entrepreneurs with their various approaches to validating deals prior to investment (a process called “due diligence”).   A few seed stage investors (angels, super angels or seed stage VCs) have coffee with an entrepreneur and quickly learn enough to write checks.  Other investors or groups of investors study deals for months before investing.  Why do some investors take longer than others to make an investment decision?  From whom should entrepreneurs solicit funding?

Many super angels, solo angels and seed stage VCs invest in very narrow business segments because they have an in-depth understanding of these verticals.  These investors can evaluate the opportunity and make investment decisions quickly (measured in days or weeks).  However, if the entrepreneur needs more money than these investors can provide, then the due diligence process may have to be repeated several times to raise sufficient funds.

Angels with a variety of backgrounds and experiences often join angel groups.  Entrepreneurs seeking capital from these groups may need to be patient because it may take 2-3 months for the members of the group to do sufficient due diligence to get comfortable with investing in the deal.  These groups, however, are willing to share due diligence with other interested angel groups and can syndicate larger angel rounds than do some smaller or solo investors.  So, the total elapsed time to close a larger seed or startup round may not necessarily be longer.  That said, most sophisticated angel groups recognize that their time-to-investment is often too long and are working hard to reduce due diligence time.

Two additional factors which may lengthen the time-to-investment for angel groups:

• Angel groups must often mesh the due diligence process into the meeting schedules of the group.  If the group only meets bi-monthly and the due diligence process take more than two months, the meeting cycle may impact when the results of due diligence can be presented to the group.  Is this an appropriate delay?  Of course not…but entrepreneurs need to be aware of this possibility.
• Most members of angel groups are part-time investors.  They are at a stage of life that golf/tennis, travel and/or playing with their grandchildren are important priorities.  Angels may prioritize their activities somewhat differently than do entrepreneurs, lengthening the time to invest.

A component of the investment process often overlooked by entrepreneurs is the importance of due diligence on investors.  Entrepreneurs should be looking for “smart money,” that is, investors who have sufficient skills, experiences and networks to provide more-than-money to portfolio companies after investment.  Do you like these investors?  Can you work with them over the next several years?  Do they bring real value to your company as you build a high-growth venture?  How do you find out?  Ask for a list of entrepreneurs they have funded in the past five years?  Call each and speak candidly about the post-investment support provided by investors – mentoring, introductions to customers and partners, help in raising additional capital, assistance in teeing up the company for exit, etc.  Find “smart money” by doing your own due diligence.  And, if investors refuse to provide you with the names and contact information for companies they have personally funded…move on.  All legitimate investors will be more than willing to share their references with you.  But…you need to ask.

Due diligence is a two-way street.  Check out your potential investors while they are validating your plan.  And, realize that raising money takes time – more time than either entrepreneurs or investors usually anticipate.

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