People in the startup ecosystem tend to think that “learning from bad decisions” is a lesson that mostly entrepreneurs must learn; however, the truth is that as investors this is also a key lesson to learn before it is too late.
There are two main mistakes that VC investors can make: 1) invest in a startup with no growth DNA and, 2) overlook a great (unicorn material) startup. Personally, the latter gives me more regrets because it means that I missed the spark of the startup, the team or the market.
As you can imagine, through my career in VC I have conducted several due diligences and analyzes of a variety of startups. Because VC investment cycles have a duration of 5-10 years (I have been in VC for 2 years), I have not seen the results of the suggestions I have made to my MDs (“I would invest here/I would NOT invest here”). However, for me, that was not a deterrent to reflect about the way I conducted my due diligence processes before. I have come to understand that as a VC investor you are more likely to miss a good investment if you analyze startups from a negative perspective. Let me explain further: trying to find reasons why NOT to invest in a company is a question that investors need to answer to be aware of the risks of the investment, however, the answers to this question should NOT be what defines whether to invest in a company. Why? Because all companies in an early stage will have weaknesses/setbacks (i.e. “the team does not have experience in X”, “the user experience needs to be improved”, etc.).
So how to reduce your probability of missing a good deal without filling your portfolio with under-performers? Conduct your due diligence from a positive perspective.
How to do it?
- Make sure the startup has the “basics”: a) great team; b) solves a need in a specific market or develops a product/service that will make people’s life easier or better; c) has a clear business model and; d) has a competitive advantage (differentiator that can not be copied easily). Without these four basic checks, no matter what, the startup will not survive (unless pivoted).
- Identify the weaknesses of the startup: as I mentioned before, you have to identify and be aware of the setbacks and risks of the startup.
- Classify the weaknesses of the startup: cluster the challenges you discovered in the last point in Obstacles (challenges that the team can overcome) and Killers (challenges that the team can not overcome because any reason). If the startup possesses at least one Killer, I would reject the investment proposal.
- Assess the feasibility of the startup to surpass its Obstacles: first, understand how the startup could get over its Obstacles. Then, evaluate how realistic is that the team overcomes this Obstacles. A red flag would be if a) the team is not aware of these Obstacles, or if b) the team does not have a plan to overcome these Obstacles.
The objective of this semi-framework is to help you not to take the easy way when conducting due diligences (I consider easier to look for NOTs). This is not a replacement of your traditional due diligence process, this semi-framework could be more useful if you use it as a macro framework integrated to your usual due diligence process.
Also published on Medium.