3 ms·

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.

by DenisM 11y ago

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.
    - DenisM 11y ago
      Thank you for taking the time to answer my question! The reason I'm asking is that I keep imagining this picture: suppose there are 20 areas of economy(there are more but bear with me), and each angel knows one area well. Startups come at random from all 20 areas, so for 1 in 20 pitches the investor hears about something he understands deeply, can ask good questions and question assumptions. And so he can make an educated decision. What about the other 19? He can't judge the financials because it's too early. He has to rely on various proxies, such as interest from others (not necessarily any more qualified), the quality of the deck, the looks or pedigree of the founders (PhDs and professors are like really sexy as I found out), and so on. The likely rejection reason then comes out arbitrary, and obfuscated. Few people just say "not my area" before you even start. The startup founders are now wasting their time in 95% of the cases, unless they come with a sexy background and then investors are just piling up. Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? I don't see it happening. Am I looking in the wrong place?
      - jacquesm 11y ago
        > Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? That definitely happens. Most angels or VCs have a domain they are interested in and outside of that they will simply not participate or refer. Happened to me less than a week ago so definitely this occurs and fairly frequently. > I don't see it happening. It depends on how close to the fire you're sitting and who you are talking to I guess. In my 'backyard' it happens, frequently and the number of times that a deal is not even looked at is high enough that I never even thought this might somehow be special. Another thing that will happen is that the party that did the referral will still take part in the round but at a much lower level. This is a very fluid world you're trying to capture, local customers, connections and cliques will make up a lot of the background for such deals and you'd have to take all of those into account when you try to factor something like this into your worldview. Personally I'd rather not see angels lose their shirt in areas that are not their domain,better if that money gets spent a bit wiser and on things that they understand.

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.

by 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.
  - DenisM 11y ago
    Thank you for taking the time to answer my question! The reason I'm asking is that I keep imagining this picture: suppose there are 20 areas of economy(there are more but bear with me), and each angel knows one area well. Startups come at random from all 20 areas, so for 1 in 20 pitches the investor hears about something he understands deeply, can ask good questions and question assumptions. And so he can make an educated decision. What about the other 19? He can't judge the financials because it's too early. He has to rely on various proxies, such as interest from others (not necessarily any more qualified), the quality of the deck, the looks or pedigree of the founders (PhDs and professors are like really sexy as I found out), and so on. The likely rejection reason then comes out arbitrary, and obfuscated. Few people just say "not my area" before you even start. The startup founders are now wasting their time in 95% of the cases, unless they come with a sexy background and then investors are just piling up. Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? I don't see it happening. Am I looking in the wrong place?
    - jacquesm 11y ago
      > Wouldn't that be a lot more efficient if investors just referred unknown companies to a buddy who knows the domain area? That definitely happens. Most angels or VCs have a domain they are interested in and outside of that they will simply not participate or refer. Happened to me less than a week ago so definitely this occurs and fairly frequently. > I don't see it happening. It depends on how close to the fire you're sitting and who you are talking to I guess. In my 'backyard' it happens, frequently and the number of times that a deal is not even looked at is high enough that I never even thought this might somehow be special. Another thing that will happen is that the party that did the referral will still take part in the round but at a much lower level. This is a very fluid world you're trying to capture, local customers, connections and cliques will make up a lot of the background for such deals and you'd have to take all of those into account when you try to factor something like this into your worldview. Personally I'd rather not see angels lose their shirt in areas that are not their domain,better if that money gets spent a bit wiser and on things that they understand.