5 ms·

An unrelated question, if I may... When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is

by DenisM 11y ago

An unrelated question, if I may... When evaluating a startup in a given area, how do you bridge the gap between your expertise in that area, and that which is required to assess the opportunity? Obviously the startup founders will always project the fields of gold ripe for the taking, so you can't blindly trust that. Do you only invest in the field you know well? Do you look for behavioral clues? Do you look for your or their peers' decision? Do you look for what's in trend, or counter trend? It seems like a super tough problem, yet it hardly ever gets discussed...

jacquesm 11y ago
Hire an expert. This is routinely done during any kind of due-diligence, if you don't know the field find someone who does, get them to sign an NDA and start picking the proposition apart. Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.
- mbesto 11y ago
  Unfortunately angels rarely do due-diligence. The fees to do this for a portfolio approach (which VC's model is) are much too high.
  - jacquesm 11y ago
    The amount of money you spend on a due diligence should be related to the size of the investment. Under 100K investment 5 to 10% should be enough to keep you out of trouble. A couple of hours (or a full day) of an expert in the field that you're going for would amount to maybe $1K to $3K depending on the field. Easy money for the expert and a very cheap insurance for someone putting down 20 to 100K of their hard earned money. The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
    - shin_lao 11y ago
      That's because they know they can't do the lawyer job but believe they are inteligent enough to understand the field without the help of an expert.
    - mbesto 11y ago
      I don't disagree, but there aren't enough "experts in the field" to supply your proposed demand. In a typical diligence round, you usually have financial/accounting, legal, commercial and ops/tech diligence. Are you suggesting they find a finance expert, a ops/tech, and commercial expert and pay them $1-3k each and on each investment?
      - jacquesm 11y ago
        Assuming the angel has at least one of those skills will save some money and assuming that it's not a single person funding the round yes, that's precisely it, whatever skills the group of angels does not bring to the table they'll have to farm out. Otherwise you might as well go to the casino and put all your money on 'black'. Better odds that way. I used to work quite a bit for angels (I'm priced out of their range now I guess) and contrary to A rounds the number of bad deals proposed to angel investors is substantially higher. By the time you get to an A round there has already been a significant shake-out, all of which means some angel or group of them have lost a bunch of money. Contrary to what people believe angel investments are a lot harder to get right than later rounds. There are many more start-ups that die prior to receiving an A round than afterwards and the amounts are low enough that doing proper due diligence is not in the cards. But an abbreviated dd is (much) better than none at all.
- DenisM 11y ago
  Enginers like you and I may have the same idea of what's right, but I'd rather see an actual investor describe how it's actually happening.
  - jacquesm 11y ago
    I'm also an actual investor (but on a very small scale, I'm pretty careful) and that's how it is actually happening. Except when it isn't and there will be blood (investor blood). I make a living like doing tech dd, and when a due-diligence needs other expertise I'll be the first to point it out. This works pretty good for investors and technology people alike. Investors that don't do due diligence at all end up losing their shirt, so that's a pretty good starting point. Just abbreviate the process relative to the amount of money involved, after all, it is a risk mitigation strategy, not a risk erasure strategy (if you don't want risk: don't invest anything just sit on your money and watch it evaporate, every other kind of investment strategy will carry risk to some degree).
    - DenisM 11y ago
      So due diligence is happening after they decided to invest, right? What about before? There is a number of startups that are pitching you (the generalized investor you), and for most of them you wouldn't know enough about target market to judge one way or another. Like, you don't know about wholesale distribution of manufactured goods from mid sized companies, how can you assess if the founders are onto something?
      - jacquesm 11y ago
        > So due diligence is happening after they decided to invest, right? Yes, usually this happens after the terms sheet is signed (and for smaller investments after a letter of intent is signed or a handshake deal is agreed upon). Up to that point it is read as true that everything the founder says will check out. The due-diligence process is there for two reasons: to fulfill the 'duty to research' for a VC to cover their backs in case a deal goes bad after investment and LPs wonder how the hell they got suckered in like that as well as to simply protect the funds. For angels the situation is worse here because they don't have the funds or the organization to do this properly. > What about before? Typically a VC has a number of analyists that assess the companies that pitch them to see how solid the various commercial claims are. The accent there is usually on the numbers and the commercial side of things, which is reflected in the education of the associates (typically: finance, accounting and/or a bit of legal and commercial). Angels tend to do this part by themselves. Angels and VCs do roughly the same thing, only angels do it earlier on (when the risk is higher, companies are cheaper and the deals are much smaller so they can still participate), the biggest difference is dictated by the size of the deals, it limits the amount of money you can spend in order to determine if you spend it wisely. To make an extreme example: a full legal/commercial/technical/financial dd would cost approximately 100K or so. The bulk of that will be eaten up by the legal portion, the remainder is roughly equally split between the other parts. If you're looking to plunk down 100K as an angel if you actually did a full DD you'd be out 200K if the deal goes through or 100K if it doesn't, so then there is no point in doing DD at all. Hence my advice to do an abbreviated one scaled down to a portion of the size of the investment, but to definitely look at all these aspects of the company, if possible through the eyes of an outsider. The other important thing to remember is that doing DD puts a strain on the company you invest in, and if every angel would do a full DD on a company before investing then the company would grind to a halt during their seed round. Yet another note: for seed investments there usually isn't a whole lot to verify anyway, the company is still tiny, probably has no turnover (so financial dd becomes: look at the model), has very little technology (so tech becomes: look at the proof of concept) and so on. So everything becomes a lot simpler anyway, it wouldn't be possible to do a full process DD on a start-up that has only just become real enough to look for seed funding.

by DenisM 11y ago

jacquesm 11y ago

Hire an expert. This is routinely done during any kind of due-diligence, if you don't know the field find someone who does, get them to sign an NDA and start picking the proposition apart. Make sure there is absolutely no conflict of interest, make sure the expert will be told up front they will not be able to participate in any kind of deal and will only be paid an agreed-up-front hourly rate for their participation in the due-diligence process.

mbesto 11y ago
Unfortunately angels rarely do due-diligence. The fees to do this for a portfolio approach (which VC's model is) are much too high.
- jacquesm 11y ago
  The amount of money you spend on a due diligence should be related to the size of the investment. Under 100K investment 5 to 10% should be enough to keep you out of trouble. A couple of hours (or a full day) of an expert in the field that you're going for would amount to maybe $1K to $3K depending on the field. Easy money for the expert and a very cheap insurance for someone putting down 20 to 100K of their hard earned money. The funny thing is they don't bat an eye at spending that kind of money on a lawyer but to actually get a good look at the material it is suddenly 'a lot of money'.
  - shin_lao 11y ago
    That's because they know they can't do the lawyer job but believe they are inteligent enough to understand the field without the help of an expert.
  - mbesto 11y ago
    I don't disagree, but there aren't enough "experts in the field" to supply your proposed demand. In a typical diligence round, you usually have financial/accounting, legal, commercial and ops/tech diligence. Are you suggesting they find a finance expert, a ops/tech, and commercial expert and pay them $1-3k each and on each investment?
    - jacquesm 11y ago
      Assuming the angel has at least one of those skills will save some money and assuming that it's not a single person funding the round yes, that's precisely it, whatever skills the group of angels does not bring to the table they'll have to farm out. Otherwise you might as well go to the casino and put all your money on 'black'. Better odds that way. I used to work quite a bit for angels (I'm priced out of their range now I guess) and contrary to A rounds the number of bad deals proposed to angel investors is substantially higher. By the time you get to an A round there has already been a significant shake-out, all of which means some angel or group of them have lost a bunch of money. Contrary to what people believe angel investments are a lot harder to get right than later rounds. There are many more start-ups that die prior to receiving an A round than afterwards and the amounts are low enough that doing proper due diligence is not in the cards. But an abbreviated dd is (much) better than none at all.
DenisM 11y ago
Enginers like you and I may have the same idea of what's right, but I'd rather see an actual investor describe how it's actually happening.
- jacquesm 11y ago
  I'm also an actual investor (but on a very small scale, I'm pretty careful) and that's how it is actually happening. Except when it isn't and there will be blood (investor blood). I make a living like doing tech dd, and when a due-diligence needs other expertise I'll be the first to point it out. This works pretty good for investors and technology people alike. Investors that don't do due diligence at all end up losing their shirt, so that's a pretty good starting point. Just abbreviate the process relative to the amount of money involved, after all, it is a risk mitigation strategy, not a risk erasure strategy (if you don't want risk: don't invest anything just sit on your money and watch it evaporate, every other kind of investment strategy will carry risk to some degree).
  - DenisM 11y ago
    So due diligence is happening after they decided to invest, right? What about before? There is a number of startups that are pitching you (the generalized investor you), and for most of them you wouldn't know enough about target market to judge one way or another. Like, you don't know about wholesale distribution of manufactured goods from mid sized companies, how can you assess if the founders are onto something?
    - jacquesm 11y ago
      > So due diligence is happening after they decided to invest, right? Yes, usually this happens after the terms sheet is signed (and for smaller investments after a letter of intent is signed or a handshake deal is agreed upon). Up to that point it is read as true that everything the founder says will check out. The due-diligence process is there for two reasons: to fulfill the 'duty to research' for a VC to cover their backs in case a deal goes bad after investment and LPs wonder how the hell they got suckered in like that as well as to simply protect the funds. For angels the situation is worse here because they don't have the funds or the organization to do this properly. > What about before? Typically a VC has a number of analyists that assess the companies that pitch them to see how solid the various commercial claims are. The accent there is usually on the numbers and the commercial side of things, which is reflected in the education of the associates (typically: finance, accounting and/or a bit of legal and commercial). Angels tend to do this part by themselves. Angels and VCs do roughly the same thing, only angels do it earlier on (when the risk is higher, companies are cheaper and the deals are much smaller so they can still participate), the biggest difference is dictated by the size of the deals, it limits the amount of money you can spend in order to determine if you spend it wisely. To make an extreme example: a full legal/commercial/technical/financial dd would cost approximately 100K or so. The bulk of that will be eaten up by the legal portion, the remainder is roughly equally split between the other parts. If you're looking to plunk down 100K as an angel if you actually did a full DD you'd be out 200K if the deal goes through or 100K if it doesn't, so then there is no point in doing DD at all. Hence my advice to do an abbreviated one scaled down to a portion of the size of the investment, but to definitely look at all these aspects of the company, if possible through the eyes of an outsider. The other important thing to remember is that doing DD puts a strain on the company you invest in, and if every angel would do a full DD on a company before investing then the company would grind to a halt during their seed round. Yet another note: for seed investments there usually isn't a whole lot to verify anyway, the company is still tiny, probably has no turnover (so financial dd becomes: look at the model), has very little technology (so tech becomes: look at the proof of concept) and so on. So everything becomes a lot simpler anyway, it wouldn't be possible to do a full process DD on a start-up that has only just become real enough to look for seed funding.