What are the most important due diligence practices for deal sourcers?

I usually invest in early stage emerging tech startups so my due diligence primarily revolves heavily around the following: Market Potential: 1st principal: Is size & growth potential big enough? 2nd Order: Emerging Tech startup should have compelling value prop in large market for scalability and RoI. Can the adoption of this solution with clients drive long term benefits to the potential clients? Team & Expertise: 1st Principal: Do the founders have the execution mindset to scale & relevant background 2nd Order: Is their vision strong enough to bring in a strong 2nd line of leaders to join them? Tech Differentiation, Traction, Early signs of value, Risk Mitigation etc are other factors that I evaluate in early stage apart from LDD & FDD

Due diligence is a complex process and always run in phases within different stages of the deal process, but in order to originate the deal, the following practices could be implemented: - Most important business DD questions are covered: funders & team, market, uniquness of the business & product. These are 3 most important pillars of startup analysis; - Initial references: quickly talk to market experts and get some references on the market, founders, business etc. - 10x+ analysis: think about your thesis and understand, if the deal itself could generate 10x returns (or a different threshold returns that you target). Later you could conclude more detailed business, finance, IT, legal diligence, but not at the stage of deal sourcing.

Effective due diligence is paramount in my role as a venture capitalist sourcing deals. Market analysis involves a deep dive into trends and competition. I scrutinize the founding team's experience and commitment. Financial health, including revenue models and projections, is a must. Legal due diligence ensures no hidden liabilities. Customer validation offers real-world insights. I assess scalability and defensibility, and strategic alignment with our portfolio is crucial. This comprehensive approach, spanning market dynamics to team dynamics, enables well-informed investment decisions for optimal returns.

For Deal Sourcers, I would place far more emphasis on the following before getting into the deep weeds of diligence. 1) Spend an entire call just getting to know the founding team. This will tell you a lot about them personally and ethically. 2) Test the product - if you don't love it, why invest in it? How does it compare to their competitors? 3) Talk to to their customers.

Our first action is always to do an independent deep dive into the industry and the market potential. Projections are great but we need to verify everything completely. We focus mostly on Medical Technology, Real Estate, Automation, and ESG. After evaluating market potential we look into competitive edge and market differentiation. Contrary to a lot of VC/PE models we also like to invest in companies that have phenomenal PEOPLE at their core. Its easy to take the stance and we have that we have a great bench of senior talent ready to jump in and lead portfolio companies but often times the very essence of startups or mature companies for that matter is completely lost when you replace people immediately.

Depending on the stage of investment, the value and expertise of the team needs to be looked at differently. Team always matters, when it comes to commercializing a vision and translating ideas into revenues and a real business. However, team matter most at the earliest stage, therefore here we need to weigh it heavier in DD. At later stage, team still matters, but the working of the business model, margins, and scalability become equally as important.

Talk to as many ex colleagues as possible. You will be shocked, but people rarely lie, they will tell you(most times) things as they are, the good and the bad. Never skip the ex colleague reference calls. You will have a much better understanding of who you are investing in. Also, send them to people that have never met before and after the call ask them about how they would evaluate the team.

An essential due diligence practice for deal sourcers is the thorough evaluation of the target company's team. Assessing the team involves more than just reviewing their resumes; it's about understanding their dynamics, experience, and capability to execute the business plan. Key questions include: How well does the team work together? What unique skills and experiences does each member bring? How have they navigated past challenges? In my experience, a company's success is often closely tied to the strength and cohesion of its team. Therefore, evaluating the team's expertise, leadership abilities, and track record can provide significant insights into the company's potential for success.

One dimension that is difficult to probe is the relative life position of each team member. This requires more than just reviewing their professional status; it necessitates that an understanding be developed of each member’s situational context. Evaluate adversities, existing or potential, and each member’s capacity to mitigate and continue to efficiently contribute to the venture. It’s also important to ascertain potential effort-level mismatches: is each member proportionally contributing relative to their reward potential? If not, then it’s an indicator that perhaps a member may not be sufficiently motivated, that their motivation may not sustain itself over time, or that team friction could otherwise emerge at a later point in time.

For early stage venture capital deals I would say that team due dilligence is the first, not the second step. As per gen. John Gronski qoute - read people more than reports. Relevant technical/professional skills as important as character traits, especially resilience, perseverance and team dynamics. Startup journey is tough, founders & key employees are really key in its success. Ability to learn fast, handle rejections, be open to reccomendations and inputs, yet making your own decisions is also very important.

Part of doing a good due dilligence is to always try the product ourselves and ask the current existing users ourselves, never take anything for granted. Typically we can identify a good product or not pretty quickly as we have been exposed to so many solutions in this current Era.

The difference in investor risk from a "prototype-stage" vs. a (first) proof-of-concept in market sales is huge. If a product has already hit the market, not just try the product yourself, but speak to several customers about it. The key focus should be: does the product/solution really solve a (crucial) problem?

The best way to test the product is to speak to a sample of end users. Although this is the highest quality signal but it is time intensive. To get a broad signal, using product review websites (e.g. Capterra or G2) is also useful. It is important to benchmark the product with its competitors. Additionally, analyzing the retention rate of different cohorts can also give a solid signal about product engagement. If earliest users tend to stick to the product, it is a good sign of product competence.

Always surprised how many people invest in companies without testing and understanding the product. Use it. Talk to customers - ideally some that you identified and not just reference customers named by the company. If possible always use the product, also after DD when the deal is done. Provide regular feedback. If possible, test also competitor products.

A SWOT analysis is designed to facilitate a realistic, fact-based, data-driven look at the strengths and weaknesses of an organisation, initiatives, or within its industry. The organisation needs to keep the analysis accurate by avoiding pre-conceived beliefs or gray areas and instead focusing on real-life contexts. Companies should use it as a guide and not necessarily as a prescription.

Again, for early stage there might be little, if any, financial statements to look at, so you focus on the budgets instead, burn rate, discretionary vs non discretionary, fixed vs variable cost items, follow-on investment risk and potential. The startup most likely will test and pivot many pricing strategies, but it is important to understand the monetisation potential and the teams’ ability to sell. Often technical part is much stronger than sales, customer acquisition and retention. B2B, and B2G in particular, have very lengthy and complex purchacing decision making processes that a startup should be able to address and survive

Business model is what make or break a company in most cases, a good product without a good pricing model will only lose its true potential. Always do a proper calculation and understand how the business operates, try to identify any inefficiency, weird work flow and process, unnecessary expense, unit economics, and relate it to the Market Size and opportunity, whether is it the right business model yet for the business?

Commercial due diligence to address the market you are entering and an independent review of the target business plan are key before the final decision is made.

For pre-seed and seed stage startups, which are my focus, I am less worried if the commercial model is not perfect yet. It is important during due diligence to understand the thought process of the founders, and their ability to think structured and strategically. But if they are areas for improvement in the business model , that’s actually an area where I see a lot of upside potential, and value a VC or Venture Studio can bring in to help grow.

Competition is not always with the other players with similar products. It is often with the "status-quo" solution. For instance, in one of the deals we were evaluating the company was operating in a highly unorganised market with several players with similar offerings. But they were not the real competitors - the real competition was pen and paper. So viewing competition from the lens of what is the current status of doing that job is useful.

Product vs problem. It is very imoortant to understand if the startup is solving a real problem and test assumptions with the minimum viable product. Asking client refferences is great and a must, but if it is pre-revenue stage with a prototype still in the development, ask potential clients, if the problem being addressed truly hurts. The client pain should be either big enough so that they will be willing to pay, or minor but annoying enough to pay and forget

Competition is what grows the industries and categories. Always do comprehensive understanding research on the similar business model, whether conventional and old existing business to other Hi-tech startup company that is trying to disrupt similar market opportunities. With deep understanding on this, you will be very objectives when it comes to selecting the right startup to bet on

Understand the competitive environment in which the target operates. Identify key competitors, their strengths, weaknesses, and market share. Assess how the target differentiates itself and its competitive advantage. Auditors report on the company's competitive position and the strategies adopted, providing insights into how the company navigates its competitive landscape.

One of the three most important strategic risks is a competitor's risk. Due to overconfidence in oneself and the product being developed, the risk of competitors is usually underestimated. What about comparing products, features, prices, strengths and weaknesses? Because this research requires much different information, it is usually done superficially. All this leads to a negative result.

A legal and regulatory due diligence is critical to avoiding major issues down the road. The cost of a thorough due diligence review upfront pales in comparison to the penalties and fallout from non-compliance issues discovered post-deal. A seasoned due diligence team with deep expertise in the target company's industry is essential. They understand the key regulations and compliance issues that must be thoroughly vetted. This expertise is paramount to knowing where to look to spot potential red flags. Assessing compliance risk, identifying gaps that need to be addressed pre-closing saves major headaches and costs down the road. When done well, a legal DD ultimately protects value over the long-term.

Don’t major in the minors. Focus on key points that can’t be fixed later. Key areas for early-stage startups are e.g. IP, customer contracts (liability, no exclusivity), and for data privacy: not primarily legal formalities but how things are done in practice, e.g. how was data collected and for what purpose is it used. I don’t believe in law firms’ one-size-fits-all checklists. Because startups are paying for these legal costs law firms and many VCs don’t worry too much about unnecessary efforts. I think VCs should be cost sensitive and only focus on what matters. The money can be used better for other things. Very few VCs have in-house lawyers and do legal DD themselves. If they do, it’s a saved cost and additional value for the company.

While a generic legal due diligence review is a necessary and beneficial part of company review, there are many situations where you should focus the legal review to certain areas. Sometimes the strategic objectives of the deal, or the company's operations are heavily dependent on legal aspects, in which case those particular aspects would benefit from extra scrutiny. Or, if the review should be limited due to cost or timing concerns, focus helps in prioritizing. Another way to ensure the fit of the legal review to the deal objectives is ensuring that the review team has experience from the target's field of business.

Ensure that the target complies with all relevant laws and regulations. Conduct a comprehensive review of legal documents, contracts, and agreements. Identify any potential legal risks or liabilities that could impact the deal. Read the Auditors report for easy understanding, CARO 2020 require auditors to report on the company's compliance with various laws, providing an overview of the legal and regulatory framework within which the company operates.

In my experience, funds may proceed with an investment even if legal due diligence results are unsatisfactory. What matters most in due diligence is the follow-up action. Providing lawyers with comprehensive information is crucial. The results of the analysis and key risks report can help the target company mitigate risks effectively. Key and high-risk aspects of legal due diligence encompass reviewing contracts and legal documents to uncover risks, assessing intellectual property assets for infringement risks, ensuring compliance with permits and regulations to avoid hefty fees, understanding ownership structure for stability and decision-making insights, and disputes research to gauge their impact and develop mitigation strategies.

Take the time to get to know the person behind the pitch deck. “Human” data points can make or break an investment. Thorough due diligence on founders, and for LPs, on VC managers, is crucial due to the significant risks posed by character flaws. This process should extend beyond traditional background checks to include detailed references from past employers, employees, business partners, even social media posts. Often, promising investments on paper can unravel upon discovering issues like deceit, abuse allegations, or workplace harassment. It's essential to understand the full story and perceptions of the people you invest in because you are giving them a piece of your own reputation that you’ve worked your entire life to cultivate.

The following areas also require scrutiny: 1/ Team: There are visible indicators like education pedigree and professional achievement. I also focus on evaluating founders' commitment. Building a successful company is incredibly hard and the honest truth is that not everyone is cut out for it. 2/ Funding History: how much was raised, when and what instrument was used. This tells a story of Founders' aggressiveness on valuation, traction and other factors. 3/ Cap Table: Study their cap table. Founders should own enough of the company for the company's stage. Be sure to get the fully-diluted pro-forma version. This will include the dilution from convertible instrument and other unissued equity which is otherwise not reflected.

You will want to evaluate the team’s ability to successfully execute on the strategy and what leverage they have as a team to position them to outperform the competition. Evaluate their strategic and market positioning which is determined by factors such as strong relevant networks, strategic partnerships, growth opportunities, market opportunities and unique value propositions.

Investment analysis is a nuanced and multifaceted process, far from a one-size-fits-all approach. In the early stages of ventures, the emphasis lies heavily on the team—their passion, expertise, adaptability, and synergy—while financial projections and market size remain crucial. As startups progress into later stages, data-driven insights take center stage. Evaluation pivots towards financial health, growth metrics, unit economics, and market traction. An integrative approach, maintaining a comprehensive view and adapting to evolving priorities, ensures that VCs make decisions grounded in solid foundations, resulting in well-informed choices.

One thing I always talk to founders about is beginning at the end. Building a VC-backable business is like writing a great screenplay...you start with the ending. When doing due diligence, I like to see that founders have at least two potential buyers in mind for their business. Understanding what your potential acquirer is looking for, and what multiple they tend to pay, will give a founder guidance on where they need to be in terms of ARR in order to command the appropriate amount of return for their investors. Once they have this information they can then make a plan to reach that ARR level over the next five years. As a VC, I recognize that everything won't go exactly as planned, but I need to see that the founder has thought it thru.