The Investor’s Due Diligence
To better understand the risks of an investment, it is important to perform some level of due diligence. Due diligence, in this context, is simply the research a prospective investor performs to make sure he or she understands, as well as is possible, the situation and opportunity represented by the company. As mentioned previously, part of the goal of due diligence is to better understand the four major categories of risk:
* Market risk
* Technology risk
* Funding risk
* Team risk
At the same time, the prospective investor is getting to know the management team, and has an opportunity to better understand the company’s direction and strategy.
The Company’s Due Diligence
It’s worth mentioning that while the investor performs due diligence on the company, the company is most likely performing due diligence on the investor. (Or at least that’s what the company should be doing.) It’s important that this looks like a good match from both the investor’s and the company’s points of view.
How Much Due Diligence is Enough?
Angel investors typically perform less due diligence than venture capital firms. Clearly, the angel has fewer resources available to perform due diligence, and the amount being invested is less than what a venture firm would invest. On the other hand, the angel is investing his or her own money, so a certain amount of due diligence is certainly prudent.
According to research by Robert Wiltbank of Willamette University, Angels spend an average of 50 hours of due diligence for each investment. But in some cases, an angel may spend 200 hours or more. An angel may invest based primarily on discussions with the management team, a review of the business plan (if a complete business plan exists) and perhaps talking with a few other people who have knowledge of the company’s industry. Since the team is always the most critical factor in a startup’s success, checking some team references is also advisable.
Spreading the Load with a Team Approach
One advantage of joining an angel group, or at least looking at a particular investment with other angels, is the opportunity to divide-up the due diligence work, reducing the burden on each individual investor. This approach has the added advantage of leveraging multiple people’s expertise and industry connections.