What Is Due Diligence Process? | My Top 5 Steps For Vetting Amazing Opportunities

Welcome to another article from my Angel Powwow Educational series of blog posts.

Today we’re going to answer the question, “What is due diligence process?” and discuss my top 5 steps for vetting amazing opportunities.

Before we dive in, I want to define due diligence. If we go with the dictionary definition, we come up with “reasonable steps taken by a person in order to satisfy a legal requirement, especially in buying or selling something.”

Another way to look at it is that it’s really an investigation on your part to satisfy whatever criteria you set before investing.

The funny thing is that you’ll get ten different answers if you ask ten people to explain due diligence. Now, many will have similar descriptions, but, in the end, everyone has their own take on what it means to them.

Not only will I share my due diligence process with you, but I’ll also explain which aspects are most important to me. In fact, I’ve ordered my sections below from most important to least important, as far as I’m concerned.

Before you start evaluating opportunities to invest in, take the time to define an investment policy statement. An investment policy statement helps you define your goals, limits, comfort level, experience, and so on.

Once defined, an investment policy can be used to quickly vet opportunities to make sure they align with your investment strategy. It’s one of the tips I list in my 10 Best Investment Tips article. I’ve even created an Investment Policy Creation Tool that Angel Powwow paid members can use to define it.

Again, each investor has their own risk level and preference as to what’s most important to them when vetting an opportunity. Feel free to adjust your strategy as you see fit.

THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE SEE MY AFFILIATE DISCLOSURE FOR MORE INFORMATION.

Let’s begin…

1) It’s All About The Founder & Team

I believe there’s a saying that goes something like this: “You don’t bet on the horse. You bet on the jockey.” Nothing can be more true when it comes to investing in startup opportunities. The right team can make all the difference between a successful exit and a complete flop.

If there’s anything that you take away from this article, let it be that the team is of utmost importance.

So, what do you look for when vetting a team? That’s a great question. Here are things to consider:

Experience:

Does the founder have significant experience in the sector this startup is in? I say significant because the length and level of experience matter. You don’t want to invest in a startup with a founder who claims relevant experience when, in reality, they worked as a busboy 5 years ago at Chili’s and think they can start a restaurant company now.

Take the time to look at the founder’s background. Does their experience seem like a good fit for this new endeavor?

Now, if they don’t have the relevant experience, that doesn’t necessarily kill a deal. In such cases, look for the team that the founder has put together. Do they fill in any gaps? What’s still missing?

Once you’ve answered your questions (and believe me, you’ll come up with some), move onto the next step.

Work Environment:

How does the team work together? Are they in the same building? Is it totally remote (Zoom calls, etc.)? Do they work well together? These are all things to consider when evaluating the potential success of a team.

If they are dispersed all over the globe and never work face-to-face, will that hamper efforts? Are there any infighting or personality clashes? Founders or team members that don’t get along won’t help the company’s chances.

The Complete Package:

Have they filled all the necessary positions to build a successful company? This is different from the experience section, where you’re looking for more immediate positions like Greeter, Busboy, Server, Chef, etc. Instead, think CEO, CFO, CIO, Sales, Marketing, Support, etc. Can you think of any positions that remain unfilled? If so, is that position critical to the success of the company at this point?

Previous Exits:

If you’re lucky, you’ll find yourself a serial entrepreneur. Someone with one or more successful exits under their belt. They have the experience and a track record to prove it. Such a history can go a long way toward pushing their current endeavor to the finish line.

There are times when I’ve been on the fence; the fact that the founder had previous successful exits under their belt pushed me over the line.

If you’ve looked at the team and you still have questions, reach out to the founder (usually via the comments section on the raise page) and make sure they answer them to your satisfaction. If not, move onto the next deal. There are so many to choose from.

Once you’re satisfied with the team, it’s time to move onto the numbers…

2 ) Let’s Crunch The Numbers

OK, the team has passed muster. Now, it’s time to dig into the financials.

Sometimes, you’ll be looking at a company just getting started and has no numbers to crunch. This can be the case if the company just started this year and has not filed any financial statements. In such cases, you have to go with your gut, what the company has presented on their raise page and anything you can glean from the updates and comments sections.

Many times, a company has actually been around for a year or more. Sure, they’re still listed as a startup, but, believe it or not, it takes a long time for a startup to get going to the point where they’re ready to move onto the next level and start raising funds through crowdfunding. In such cases, there will be official financial filings that you can use to help in your due diligence process.

Enter the Form C. Most companies on the popular crowdfunding sites will file a Form C. Sometimes you’ll find a company going the A route, and you can glean similar information from that filing, but we’ll focus on C for now.

The Form C is a great quick look at a company’s financial status. You can see their assets, debts, revenue, costs of goods sold, tax payments, net income/loss, and more. What’s even better is that, if it’s available, you get to see the current and prior reporting year’s data. Guess what that means? You can see a small trend in each of those categories.

Now, you can see things like, has revenue increased year over year? How about Net Income/Losses? Do assets cover debt? The list goes on and on.

Frankly, the Form C data can be nearly as important as the team.

Before we get too far down the rabbit hole, don’t rely solely on the Form C data. It’s a great indicator of a company’s direction, but there are times when certain YoY movements can be and one-off and explained by either a special contract or a one-time expense, such as needing to file an FDA application. Read the data and make sure to ask questions if anything looks too good to be true or not quite right.

I rely so much on the Form C information that I created the Angel Powwow Form C Tool (available to Angel Powwow paid members) that helps me to visualize the trends and calculates things such as revenue or net income to valuation multiples, value, and percentage changes, and so on. It even goes as far as to color-code each result (green for good, yellow for either/or, and red for bad, etc.). I share my Form C Tool results on opportunities that I bring to the Angel Powwow forums to help other members in their decision process.

It’s at this point (after the initial idea catches my eye, the team looks good, and the Form C results are known) that I decide whether or not to share an opportunity in the Angel Powwow forums.

Like with the team, if you’re concerned or have questions about the finances, ask in the comments section of the raise page. Otherwise, if you’re happy with the numbers, it’s time to move onto the process…

3) Processes Can Make Or Break A Company

The process is so important. What do I mean by process? I mean, how does the company operate? How did they spend the money they already had, and what are their plans for the money they’re soliciting from you?

If the company has been around for a little while, dig into their filings and see how they’ve spent the money they’ve raised thus far. Does it make sense? Did they waste it? Was it mostly used to pay their top-brass?

If the spending trend thus far has been reasonable, chances are they’ll spend the money you give them wisely. If not, it may be time to move onto the next deal. At the very least, ask them about it. Maybe they’ll admit there was a mistake and share how they plan to mitigate such issues in the future.

Once you’re happy with the past spending habits of this company, it’s time to look at the planned use of funds for this current round.

Again, it all boils down to the expected spending making sense. Sometimes that means a large portion for salaries to hire the talent they need to move forward. Other times, it might be a big marketing push. Be wary of uses that are to pay off debt or the head honcho’s salary.

If the process looks good, it’s time to look at the idea itself…

4) What About The Idea?

I know a lot of you are thinking, “Isn’t the idea the most important thing?”. To that, I say, “Yes, and No.”

I’ll admit, the first thing I look at is the idea. That said, I only look at it to see if it intrigues me. If so, I move to the team right away and then move down my list.

When I get to the idea stage, I take a deep dive into it. Here are some questions to consider:

Is It Game Changing?

Will this solution create a new market or be a catalyst for massive change in the current one? If the answer is yes, that’s pretty amazing.

Is this a new idea, or just a rehashing of an old one?

New and innovative ideas are a great indicator of potential. Redressing an old one can be OK, but you’ll need to ask yourself if it’s really needed or even wanted.

Does it address a need or pain point?

Is this solution actually tackling a real problem? Is it a good fit?

This can be a great indication of the market potential.

Is it a must-have, or would be nice to have?

Let’s face it, in a crisis, the nice to have’s are the first thing to go. Must-haves endure throughout. How will the company fare in times of financial uncertainty?

What’s the potential market for this solution?

This is a critical question. If there’s only a handful of people that this solution is fit for, what are the odds you’ll make any money off of it?

When looking at this piece, Total Addressable (TAM) Market is nice, but Service Addressable Market (SAM) is better, and Service Obtainable Market (SOM) is best. SOM is basically the piece of the pie that the company believes it can obtain. If you can ask for the SOM, as most raise pages talk about the TAM to make their potential look better than it actually is.

If you get to this point in your due diligence process, you’re not quite done…

5) Keep Digging

If you’ve made it through the first four sections and the deal is still in your consideration pile, it’s time to really dig in. Here are some things you should do at this point:

Reach Out To A Knowledgable Source

If the opportunity is outside your knowledge/comfort zone, seek advice from someone better educated in that sector.

For example:

At an event where companies were pitching to the audience, a medical solution was presented. It looked great up on stage (what doesn’t in a presentation?), but I’m not in the medical field, and I didn’t know enough to evaluate it on my own.

Luckily, I was sitting next to a doctor and one that specialized in the field this opportunity was addressing. I picked his brain on this one and got a much deeper understanding of the solution.

It was only after going through these steps and reaching out to someone “in the know” that I could make my investment decision.

Get Into The Paperwork

It’s time to read the actual filing documents. This is the contract of the investment. Hit that Form C and any supplemental filings. Look it over carefully and make sure you understand all the terms and so on.

Discuss The Opportunity With Other Investors

This is the main reason I created Angel Powwow. Bring opportunities that interest you to the forums. Get different viewpoints. Share your likes and dislikes.

It’s from this type of interaction that you can get a more holistic view of an opportunity and consider facets you might not have otherwise.

Think of it as a crowd due diligence platform.