Due Diligence: A Perspective

There’s a study done in 2007 by Angel Capital Association  on how due diligence affects the angel investment deals. The highlight: Angel investments in which at least 20 hours of due diligence was done, were five times more likely to have a positive return than the investments with less or no due diligence time.

Due Diligence is a process an investor undertakes for an opportunity he is seriously considering for risk mitigation purposes. Angel Investment is risky; while the process does not completely de-risk any deal, it does help make better decisions and potentially identify deals with a higher probability of a high rate of return.

Although there is another side to this story which some successful investors like Dharmesh Shah, co founder Hubspot assertively follow. Whether to do due diligence or not has been a topic of debate for many years. The other argument being: Due Diligence or detailed analysis of an early stage venture is less factual and more speculative since there is not much information available for any sort of analysis. Celebrated Investors belonging to both the categories have pretty convincing portfolios that make this debate even more intense.

Analyzing a startup deal before investing makes an investor comfortable with the founders, the team and the product. This helps in eliminating any red flags that may point towards failure as suggested by Marianne Hudson, an angel investor and also the executive director of Angel Capital Association. Then there’s the idea of investors who think the only rule in angel investment is that there are no rules. Either you like the founders or not. You like the idea or you don’t. And that’s how they would invest, getting bullish about an idea or a founder, writing them a check and actually strike bells on some of the investments which is comparable to the 20 hour due diligence rule investor.

An angel investor should be passionate about the idea he is investing in. He is responsible for mentoring the startup and help them grow. This also increases the chances for a successful exit and a huge return on the investment. Of course getting over analytical about startups is not a good practice. Often founders with good advisors on board have a far greater probability of being successful. This ideally holds true in most of the cases but it does have another take. It is also a fact that entrepreneurs love fast decisions from people they respect. They like getting the freedom of making mistakes and learn from their own experiences rather than someone else’s.

It is up to the investor what path would he want to follow. Relying on sixth sense alone, which in this sector plays a substantial role or taking a slight pain of understanding what he is getting into and just may be avoid a disaster. The right question is not: Should due diligence be done or not? Rather, What’s the harm in doing it when it increases the probability of return by a margin which according to studies is not small!