Due Diligence is often seen as not possible or relevant for an early-stage investment. Yet most business angels lose money on the majority of their investments
So, can due diligence help?
Many business angels comment that “they are taking a punt”, comforted that they are only risking a small proportion of their own capital, and encouraged by the tax credits they will receive, so do they have to do due diligence?
Equally, many business angels have also enjoyed significant success and trust their own gut feel as the barometer of an investment. Yet Nesta tells us (in their 2009 report on business angels) that “even a small amount of due diligence significantly reduces failure”.
Okay, it is true that Angel Investors are often investing money they can afford to lose – but will still experience any combination of anger, disappointment and remorse when that loss is incurred. Is that worth it?
And there are plenty of examples of Angel Investors following their “gut feel” without exploring and rationalising the causes of these feelings – something that can be an illuminating process for both the angel and the potential investee business.
Whilst Angel Investment will always be a high risk activity, there are due diligence steps that can be taken to significantly increase the chances of success.
How to increase chance of success for early-stage investments
Due Diligence can (and should) be performed on an early-stage investment, focussing on the following areas:
- The Market Opportunity:
Market size, product position and pricing
What is the value to the customer?
- The Management Team:
What are their competencies?
What are their strengths?
What are their personal expectations?
Where are the gaps – and how easily can these be filled?
- What is the structure for delivering the Business Plan?
Are the best sales channels being used?
What are the key risks in the supply chain?
- What are the expectations of investors?
How may value be realised for investors?
Working through these four questions provides structure, balance and focus to the investment process.
It also provides a much greater likelihood that the expectations of the Management Team and the investors are realistic – and aligned. This means that the relationship between the investors and the executive team are much more likely to be friendly and to work in a cooperative and successful manner.
In my experience, the above process works best if it is seen as a collaborative, rather than confrontational, exercise.
So, bite the bullet, do the due diligence. you know it makes sense.
Chilcomb helps investors and early-stage businesses through this due diligence process. Chilcomb’s Investor Checklist provides a robust structure to increase the chances of a successful investment. To find out more, go to our website (www.chilcomb.com) or contact Matthew Dreaper.