- Describe how investors carry out due diligence processes. 
- Explain the  money versus power trade-off


[SLIDE 1]

Due diligence is a rigorous process carried out to evaluate an investment opportunity prior to a deal being finalized. When considering an investment opportunity, both angel investors and VCs conduct a due diligence process, but typically, angel investors and groups do not carry out as much due diligence as VCs due to time and resource constraints. 


[SLIDE 2]

An angel or angel group generally conducts a proper analysis of the market opportunity to ensure it fits in with investment goals and carries out background checks, legal checks, and financial analysis. Angels will also consider any personal conflicts that may get in the way of the deal; different ways in which they can add value; and ultimately whether they want to establish a long-term working relationship with the entrepreneur.

An assessment will be conducted of the founding team. Angels need to like and trust the entrepreneurial team before proceeding with the investment. Qualities such as leadership ability, honesty and integrity, intelligence, and good judgment tend to attract angel investment. They will check credentials to make sure the founders have the necessary skills to lead the venture, or at least have people in mind to provide those skills. To get to know the founders better, angels often meet entrepreneurs in a more relaxed environment and visit the company's premises in order to interact with the whole management team. 

Angels will carry out a legal background check to ensure that there are no past or pending legal actions against the management team such as lawsuits, criminal convictions, and so on. Angels will also check to see if the founders own their intellectual property (IP) and have filed patents correctly.

Angels may conduct rigorous market analysis to establish the existence and size of the market for the product. This analysis includes identifying the customers and why they would want to buy the product/service; the competition -- who they are / the size of their market share / strengths and weaknesses; how the product is distributed; the pricing of the product; and how this new product differentiates itself from competitors. 

In addition, angels will check the financial risks involved before they proceed. This involves checking the accuracy of financial projections if they have been provided; cash flow and if the amount of money (together with the angel investment) is realistic enough to grow the business; the company's financial commitments and expenses -- leases, salaries to employee and the entrepreneurs themselves, loans, debts, and so forth. 

Angels may talk to a whole range of people before making a decision to invest. Some of these people include: existing customers of the entrepreneur's product/service; other angels (especially if the entrepreneur received angel investment in the past); other investors who may already be investing in the venture; and other competitors.

Finally, angels will want to clarify exit strategies to better estimate when they will realize a return on their investment. There are several options for exiting. 


[SLIDE 3]

Like angels, VCs are very careful when it comes to due diligence, particularly because of their history of making impulsive, wild investments in young companies. In general, investing in early-stage companies is risky, especially when millions of dollars are at stake, and VCs need to identify any potential red flags to ensure they are making a sound investment. During this process, entrepreneurs, their teams, and the company itself will undergo a vigorous appraisal, which generally lasts over a period of several weeks or even months. During this period, the backgrounds of the entrepreneurial team will be verified; references thoroughly checked; and corporate compliance, employment and labor, intellectual property rights, and legal issues reviewed. 

During this time, it is important for the founding team to carry out its own due diligence on the VC. It is perfectly appropriate to ask VCs for the contact details of companies in their portfolio where they have achieved success, as well as those where the deals did not work out. Talking to others who have been involved with the VC is an invaluable way of garnering information that will help you decide whether or not you will be able to build a long-term successful relationship with them. 


[SLIDE 4]

Part of the due diligence process involves the discussion of exit options. When VCs and business angels invest in a business, there is an expectation that they will receive a return on their investment when the firm exits the investment, within a certain time period, usually in around three to seven years. Typically, this money is repaid through one of three types of exit strategies: an IPO, mergers and acquisitions, or buyback. 

An initial public offering (IPO) is a company's first opportunity to sell stocks on the stock market to be purchased by members of the general public. Smaller companies are often bought by larger companies through acquisitions, which are ways for bigger companies to increase their profitability and in some cases swallow the competition. 

A less common exit strategy is a buyback, which gives the entrepreneur an opportunity to buy back a venture capital firm's stock at cost plus a certain premium. However, buybacks are rare because the young company usually does not have the cash to buy out its investors unless it has reached a highly profitable state. 

The due diligence process is complete when all the issues have been resolved to the satisfaction of both parties. Getting through the due diligence process is the final step before contracts are signed and you finally receive capital. It is also an essential part of building a foundation of trust and commitment with your investor -- and remember how important that foundation is since you will be in the newly forged relationship for years to come. 


[SLIDE 5]

As we have described, there are many funding alternatives for would-be entrepreneurs. The type of financing an entrepreneur chooses often depends on her or his tolerance for varying types of risk. Quitting a corporate career risks the loss of a stable income and other corporate-related benefits. Investing personal finances comes with the risk of bankruptcy. Financing from family and friends risks ruining meaningful relationships. Accepting financing from investors runs the risk of eroding the entrepreneur's vision of creativity, company culture, and decision-making autonomy. Entrepreneurs, therefore, risk so much more than financial investments; they also risk personal relationships and the emotional well-being associated with the health of the business.

Yet being willing to take responsible, calculated risks is central to the entrepreneurial mindset. Instead of agonizing over what is given up in pursuit of an entrepreneurial opportunity, the key is to focus on what is to be gained. 

Let's take a deeper look.


[SLIDE 6]

Very few entrepreneurs manage to make money and maintain full control of their businesses. Entrepreneurs who give up a bigger slice of equity to investors tend to build more valuable companies than those who give up less equity or none at all. Any investment comes with a price, and before you sign on the dotted line, you need to have a very clear idea of how you want to run your business and what matters to you most. 

By giving away equity, you will have less control over your decisions and may even be at risk of losing your position as CEO. Why? Because once you give up equity, directors will join the board and will take over much of the decision making, including the decision to either keep you as CEO or move you to a different position, or even push you out of the company altogether. 

For example, a study of 212 US startups from the late 1990s and early 2000s showed that 50% of the founders were no longer the CEO after three years. In fact, the same research shows that four out of five entrepreneurs are forced by investors to relinquish their CEO roles.

Being pushed out or moved to a "lesser" position can come as a real shock to entrepreneurs who have worked tirelessly on building their ventures from the ground up, as well as to employees who have worked alongside them. In fact, the way this leadership transition is handled by both the investor and the entrepreneur can make or break a company. 

One of the most common mistakes founders make is believing they can grow the business through inspiration, passion, and perspiration. While these three key elements are helpful in getting a business off the ground, entrepreneurs need better resources to fully capitalize on future opportunities. As a company evolves, it needs different skills to grow into a more valuable business.

For example, a startup that has developed a product may not have the expertise or financial resources to market and sell it to customers, or the know-how to set up after-sales service. This means relying on people with different skills like financial executives, accountants, lawyers, and so on. 

More employees may need to be hired and a new organizational structure put in place. All these elements can be overwhelming for a founder and team who lack these skills. 

Of course, it is entirely possible to remain in full of control of your business by keeping as much equity as you can. You may have less financial investment to increase the value of your business, but if you have more interest in being in control (i.e., being the "King/Queen"), then this is a viable option for you. 

Thinking about what matters most to you -- to be rich or to be all-powerful -- is a useful exercise in how you define success and what it means to you. As the figure illustrates, maximizing control over wealth and vice-versa can negatively impact success. While the ideal would be to make tons of money and be completely in control, history shows that few entrepreneurs have managed to do both.