Doing Due Diligence on Startup Team

Investors experienced better returns in the deals where they exercised more due diligence. Sixty-five percent of the exits with below-average time spent on due diligence reported a return that was less than their original investment. Losses occurred in only 45 percent of the deals where investors did above-average due diligence.

– Kauffman Foundation and ACEF

Ask any seasoned investor and he’ll tell you that one of the most, if not the most, critical aspects of a deal is the management team. Doing your due diligence and knowing who are running the business can make the difference between scoring a homerun and losing your shirt.

Pro forma. Growth strategies. None are as important as the people on the team. Everything in the startup plan will change. It’s the people who’ll be there for a long time. Just because Rosy the CEO has a laugh that reminds you of your college sweetheart and even looks a bit like her in the right light doesn’t mean that you should let the warm fuzzies of your university days override the need to dig deeper.

So how do you know if Rosy would be an ideal founder? Look for these traits:

• Adaptable: The only thing consistent in a startup is change. Rosy must be willing to switch gears to adapt to changing market needs, rather than to blindly follow a plan that’s “so yesterday.”
• Clean: It’d be nice if she showers every day. But that’s not our point. By clean we mean free of past and pending legal actions and tax liabilities. Not that a suspect or convicted criminal doesn’t deserve a chance but let’s try not to do it on your dime. No need to add complexity and unnecessary risk to the already risky angel investing game.
• Fundable: What’re her motives behind starting a business? Prudent investors don’t back lifestyle entrepreneurs, people who go into business for lifestyle reasons rather than for financial wealth.
• Honest and moral: There are much less formalities in startups, which means lots of stuff will be based on trust. If your gut tells you Ms. Rosy isn’t trustworthy, forget it. Your gut could be wrong, but under no circumstances should you deal with someone you can’t trust. Run to your next opportunity.
• Inspiring: At the startup stage, the company has nothing more than intellectual property. The ability to lead by inspiration and propel the company to the next level is vital to the prospects of the company.
• Qualified: To take the startup from zero to profitable, Rosy must possess the necessary skill set and experience. If she doesn’t, she should have a solid, convincing plan to attract talents to fill critical positions. Ideally, these talents are already on the team before Rosy approached you.

Talk with the founder and you’ll learn a little about her traits and character. But that’s not enough. You should request and talk with professional references, and do credit, character, and background checks on her. And you’ll do similar checks on current execs.

If her family or friends are on the management team, then you need to find out why they’re hired. If they’re employed because she’s doing them a favor, not because they’re qualified for the job, take it as a sign that she suck at making good decisions and sound judgments – certainly not someone you’d want to invest in.