Due diligence is the investigative process of verifying the accuracy of information so a prospective party (investor, buyer, founder) can make an informed decision before committing to the other party. In the startup space, due diligence is always conducted by the investor; however, startups often fail to research their potential investors. In the same way investors carry out due diligence, entrepreneurs should also seek to uncover weaknesses, potential risks, as well as liabilities of their investors.
There are two types of investors: individual investors (angel investors, high net worth individuals) and institutional investors (venture capitalists, corporate venture capital, private equity firms). The process of conducting due diligence is similar, and startups should undertake this process every time they engage with a new investor, or renew an arrangement with a current investor.
What To Look For In A Potential Investor
Experienced investors will view the process of due diligence from entrepreneurs as a sign of seriousness and professionalism. Potential investors should allow you to engage in reverse due diligence. If they won’t, that is a red flag. In addition to this formal check, it is always good to spend time with your potential investors in a non-work environment to see whether the relationship will work. There are a number of things to look for in a potential investor, venture capitalist or angel.
- Background checks (such as criminal and credit)
- Conflicts of interest (what industries has the investor previously invested in, and are there any complementary or competing investments?)
- Check the statistics or figures given (conduct formal audits)
- Success of previous investments (including size and venture stage)
- Objective of investment (is it to increase return on investment, a strategic decision or seeking diversification)
Where To Look For Information
You can research information on potential investors in a number of places:
- If your investor is a part of a venture capitalist group, accelerator or incubator, start off with the affiliated website for the group. What are their prior investments? What is the industry focus? Have previous startups succeeded with this investor?
- Leverage LinkedIn and find out who your investor is connected to and whether they have been endorsed or recommended by others. You can also see the employment history of the investor. Also, check out sites such as AngelList and CrunchBase.
- Talk to other investors. The startup scene in Australia is still relatively small, particularly those involved in startup investment. Other investors should be able to tell you whether your investor is good or bad.
- Social media and news websites. Investigate whether your investor has appeared in the news for any controversy (or even better, if they have signed big deals)
The due diligence process with startup investors is a two-way street. Entrepreneurs often fail to conduct their own due diligence of their investors, venture capitalists and angel investors. Not only is due diligence in the capital raising process imperative by entrepreneurs, but it is also an iterative process. Conducting due diligence will provide peace of mind when it comes to deciding who controls what.