"Due Diligence is the mother of good fortune"
- Miguel De Cervantes
In 2008 Bernie Madoff was arrested for running one of the biggest ponzi schemes in American history. He had been in business for 48 years and lost over 18 billion dollars for thousands of investors that trusted him. Madoff may still be in business today if it wasn’t for one analyst who spotted the problem after only 5 minutes of researching the business.
When one of the top market makers in America was brought to its knees, the need for improving the diligence processes became glaringly evident. Some would say that it was the catalyst for the vast array of apps and tools that help us make better decisions in our daily lives. Whether it is buying a home, choosing a school, or even deciding where to eat we have a bevy of resources at our fingertips to help inform better decision making.
Today, seasoned investors and venture capital firms not only do their own due diligence, but also hire third parties to assist in the process. Just like a modern day venture capital firm, you should take your own steps to developing a personal diligence strategy. In order to help you get started, we took a look at strategies from investors and venture capital firms and condensed them into a starter kit.
Take a look at the top 5 due diligence tips when investing in startups through equity crowdfunding, and also check out the very bottom of the page for additional links that cover due diligence in startup investing. Finally, be aware that no amount of diligence can protect you completely from fraud or failure. In some cases, even the best investors do not see success, which is something we will go into later on in our investors’ series.
You are not just investing in an idea, but in the people behind the idea.
When doing your research start from the top and work your way down. Founders are going to be the first person that potential investors look at when assessing the business. They have built the business, are the face of the company, and are one of the most important parts of the business succeeding. If the founder doesn’t fit the bill, how do you expect the rest of the company to succeed? In that case, here are some questions to think about
Questions to ask yourself:
- Are they in the business for the right reasons?
- Do they inspire both employees and investors?
- Are they devoting all their time into this project?
- Are they intelligent?
- Are there any past issues that would warrant concerns? (Legal, Social, Past Work Experience)
While a leader is essential in guiding the business, the people around him or her are just as important. The questions that we ask ourselves about founders, can also be attributed to other team members. If they lack necessary skill sets, experience, or even inspiration it could be an early warning sign that a business is in trouble.
You may be asking yourself how you can find the answers to these questions. As an equity crowdfunding investor you don’t have the same luxuries that angel investors and venture capital firms do in getting to meet these people face-to-face.
- Social Media: Did you know Linkedin started off as a platform for early stage entrepreneurs to showcase themselves to potential investors? Not only is it a good place to start because it gives you immediate insight into their job history, skill set, and peer reviews. From there, you can move to platforms like Twitter that provide great insight into a less formal and potentially more real view of who they really are.
- Search: Once you have their general background, you can do some detective work through Google Search. Start with their name, and set your date range for specific periods of time. If you are still unsure, use the relational data you found through social channels to see if you can find any other insights.
- FlashFunders Account: When you create an account on our platform, you get access to speak directly to the startups raising capital through the comment thread. On top of that, we also allow you to follow startups so you can sit back and watch the funding round from a distance. Not only will you get updates on questions from other investors, but you will receive a direct link to founders and their team through email.
LOCATION, LOCATION, LOCATION
For centuries, great cities were defined by their geography. Four of the largest cities, both locally and globally, have direct access to large bodies of water because it was essential for trade and shipping. While our waterways are still essential, there is a growing belief that a great city can be born based on the people instead of the geography.
"Now you could make a great city anywhere, if you could get the right people to move there. So the question of how to make a silicon valley becomes: who are the right people, and how do you get them to move?" -Paul Graham
You may be asking yourself “What the hell does this have to do with my next investment?”. Well, think about Uber being built in Alaska. Great idea, but a really bad location for it. Most successful startups succeed in 6 major cities with Silicon Valley dominating first place. Entrepreneurs flock to these cities because of the human resources available, and looking at the statistics of startups raising capital through equity crowdfunding, the location bias still exists. Startups in or around Silicon Valley have the highest amount of startups looking for funding through Regulation CF, and almost 2x the number of funds raised compared to any other city or county.
Location may not make or break your potential startup investment opportunity, but you do face a higher amount of risk if they fall outside of the major startup hubs where there is more access to investors comfortable writing big checks to early startups.
Congratulations on making it this far. If you would like to know more about the due diligence process, check out part two of our series here. If you would like to get updates on the rest of our startup investor series, you can subscribe in the box above or sign up for a FlashFunders account below.