There are many approaches, methodologies, and schools of thought on how to conduct due diligence in startup investing. The earlier the company, the less that can actually be known. With so much unknown and to be determined, getting at the motivation and tenacity of the founders is essential. That frames the essence of the bet both founders and investors are going to take.
Of course I like a good financial model (never seen one that doesn’t scale up rapidly) or total addressable market (TAM) slide (never seen one that says the market is small). I more lean into what does it look like when the company is at $1M, $5M, and $10M in revenue, the cost structure to support that, how fast can they get there, and what does the market to get there look like from a bottom’s up perspective. Things like how many companies of your perceived ideal customer profile exist and how will you reach and convert them on positive economics. I did a post about all that back in 2021 “What We Ask In Due Diligence” that you can read.
In the meantime, let’s focus on the most important question (to me) an early stage investor needs to get an answer to during due diligence.
What would it take for you to quit?
At this point in my wandering career I have made over 70 early stage investments as both an angel investor and venture capitalist. I have had the privilege of watching many of them play out over the years with all the twists and turns along the way.
Sometimes (often) startups don’t work out as desired. There can still be success but there are many degrees of that and, in some cases, it merely means finishing well and winding down in an orderly manner. That is part of the equation as well and how you finish matters more than how you start be that with great success or total failure. You have to finish the drill completely if for no one else than yourself so you have lived the experience, have a story to tell and finish with your reputation intact.
Anyone doing early stage investing should know the risks including a total loss of capital. If they don’t understand that then you as a founder should think twice about taking their money.
So back to the question – “what would it take for you to quit?” To me, at the earliest of stages of investing this is the number one risk for an investor. For my fund, we are not structured or equipped to step in and run the company should the founder or founders walk away. The founders are the soul of a startup and essential in its creation and early growth.
So, what insight led to asking this question you might ask?
A post-mortem discussion on an investment we made where the team, literally, quit to take jobs with a big techco. What did we miss? For starters, we didn’t ask them this question, together, as a founding team.
Now that we do ask it I get all sorts of answers from “Never!” to “Not til the IPO baby!” to “Hmm, I hadn’t thought about that.” Most times that question has never been asked of a founder or founding team and it is fascinating to hear the answers especially among founders that have not had that discussion prior.
One of the more memorable answers and might very well be the best one went something like this: “Well, if we try what we think will work and it doesn’t and try all the other things we think will work and they don’t then maybe it would be time to see if this was actually still worth spending the time and energy doing.” An honest and informed response.
Startups are hard. Being a founder is hard. The journey is a series of big advances and enormous setbacks and getting at how founders are considering that journey out of the gate is essential and, to me, the most important thing to understand in due diligence.
Venture Vice 