One of the purposes of doing due diligence is getting to a NO. That may seem uncomfortable and unfair to entrepreneurs. The simple reality is no one can invest in everything. The quicker the NO, the better it is for the entrepreneur. They can move on.
I try to get to a no as quickly as I can. Sometimes it’s by simply reading an email and knowing that the deal is not up my alley. Other times it’s trickier.
Put yourself in the shoes of the investor. They do 3-6 deals per year. They might see 1000 deals. Hunter Walk has talked about his funnel with his early stage fund. I would assume most funds aren’t that much different when they invest early.
Diligence takes a lot of time. Why? It’s a process of developing a relationship with the entrepreneur. You have to go out and meet people. You meet customers, potential customers and people the entrepreneur has worked with. You interview them-and ask a lot of questions. You accumulate data. All that brings up more questions that you might re-engage with people that you have already spoken with on.
Another step is to form up your own numbers. Entrepreneurs always give you five year numbers. They always look the same. First two years, they lose money. Third year, they break even. Fourth year they make money. Fifth year, explosive growth. Their chart almost aligns perfectly with Al Gore’s hockey stick chart.
Why should investors form their own numbers? It gives them someplace to start analyzing. It gives them some idea of how many funding rounds, and how big those rounds might be to get to the finish line. Truth be told, the investor numbers are never more correct than the entrepreneurs-but they give some context. They also give provide points of ongoing discussion with the entrepreneur to see how they are thinking about budgeting for growth.
Then there is the more personal thorny side. It’s more than just looking at the balance sheet and income statement. It’s checking to make sure all of that checks out. It’s making sure there are not any nefarious things in a person’s past. No one undertakes that sort of diligence unless they are serious.
At every single stage, an investor analyzes and if they can say No they will. It saves them time.