Swim or Die: My Personal Notes on Due Diligence

Photo by Stella Ribeiro on Unsplash

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If you have been following VCs on Twitter or Netflixing a lot, you must have known the Fyre Festival Documentary where a NY-based company over-promised (and straight up lied) regarding their capacity and under-delivered the outcomes creating a gigantic chaos in a small island called, Great Exuma. While the documentary has many cringe moments from the founders, the rich kids and utterly trusting investors, there are several key lessons from that movie on due diligence which are parallel to my experience working with seed funding deals + mini-angel investing. This blog post may be applicable to those who ever planning to throw the money in the future ICO vortex or any crowdfunding investment scheme. My rule of thumb, ONE LIE = strike out!

Team

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Every early-stage VCs would say “TEAM” is the most important when investing to ‘pre-revenue’ companies. With that, some founders play these several games to make themselves more credible:

“I quit my job to work full-time on this company aka my baby”

Problem: probably got laid off (due to redundancy, M&A or bankruptcy) from previous companies - if they did resign from their job, be aware for IP issues
Quick fix: check ex-colleagues’ LinkedIn profiles

Meaty companies' logo on the “Team” slide

Problem: they are not in the critical/key/strategic roles

“We have several people working on the project full-time” or they have several people coming to meeting, demo day or conference

Problem: very likely a solo founder
Quick fixes: check on those “people’s” LinkedIn profiles, ask for their business cards (not the founder), check company house registration for their names

“Another co-founder left”

Problem: equity breakdown may be a problem especially without founder’s agreement
This could be a quick GGWP for the company if the past founders own huge chunks of shares which no VC would be willing to invest, thence, folded!
Quick fix: ask for founder’s agreement - no founder’s agreement, no honey 🙂

Founder’s has different legal names and/or spells their names differently on new companies

Problem: the founder simply does not have a trustworthy history - expect future resentment if choose to forgive the past problems

Product

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“Cheaper, faster, better”

Problems: knock-off version of existing competitors (IP lawsuit pending especially if founders’ past works involved with competitor’s product)

• Price will likely increase in the future and new entrants will come into market with the same tagline
• That company will never be the market leader

Quick fixes (for founders): to know key differentiator, USP or different methods to solve the problems that could bring more values than the existing solutions

Unnecessary complex jargon all over the deck

Problems: most often the core product is just the existing product combines with another simple product
Quick fix: never act smart in the meeting room, keep asking ‘stupid’ questions until founders give up and tell the truth 🐵

“We use AI or blockchain to solve the problems”

Problem: mostly unnecessary and misused e.g. AI = linear regression or simple filtering feature

“We need $ to build our MVP and test our product market fit”

Problem: they can just create a wire-frame, mock-up or scruffy MVP from free services

Competition

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“We are the only company in this market”

Problem: NOPE. They’re just ignorant about the market or/and substitute products.

Startup shows the competition table and highlights where they shine or the gap in the market

Problems: the gap usually not worth solving or the competitors are working on those gaps as well

Main fix for the competition is to always find competitors or substitute products, register for the competitors’ trials and test out their features if what the startups claim on market gap to be correct and worth solving

Roadmap

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Clean, organized, structured, list of milestones/goals

Problem: always over-promised.
Quick fix: the formulas are:

1. for time frame, add two quarters;
2. for number of customer acquisition/revenue, multiply by 10%;
3. for costs, add at least 20% (higher for highly regulated sectors)

A more reasonable approach is, of course, to crunch the numbers when data is available

Miscellaneous

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Company won an entrepreneurship award/grant/competition

Problem: the award is not that competitive at all and there is no correlation that shows the award winner is more successful than its counterpart
Quick fix: ask them how they spent the award money, you will be surprised!

Company joined an incubator/accelerator program

Problem: incubator and accelerator are very lax in term of due diligence (due diligence is conducted at most for a total of 3 hours) and they also act like an ‘investment banker’ for their startups trying to get them follow-on funding
Quick fixes: ask if they have validated their products, made any PoCs or gained any traction because those are the only benefits that they can actually get from their 3 - 12 months parents

“Our current investors do not want to release unfunded commitment after achieving milestone”

Problem: there’s a problem between investor relationship management or hidden company’s problem that you haven’t discovered yet
Quick fix: RUN! My main red flag even to those who are applying for startup jobs

If you came across any lies or cheats that early-stage startups use, do comment below as I might have missed several key points on DD. If I did, I will add more on Part 2!