what to do in due diligence process startup investing

The Importance of Due Diligence when Investing in Startups

Propel(x) Team | November 22, 2021 | Fourth dimension to read: 5 minutes

If you are well-nigh to purchase a used automobile, you might ask an auto mechanic to inspect information technology before you mitt over your hard-earned greenbacks to make sure you lot are not buying a lemon. It is important to consider doing something similar if you are thinking about investing in a startup.

What is due diligence?

Putting it simply, due diligence means doing your homework. Before committing to an investment, it is of import to empathise what y'all are buying and what y'all are getting into.

Due diligence on a startup can exist divided into the following 2 components:

• Industry due diligence , which refers to the big motion picture and involves understanding the industry, who are the incumbent players in the marketplace, who are the competitors, what competitive reward the startup has, what their chances of success might be, and similar research.
• Legal and corporate due diligence , which involves a detailed investigation on the startup, the founders, contracts, corporate structure, product, compliance, contracts, offer, and more than. On the Propel(ten) angel investing platform, this component is called Broker Review .

Importance of due diligence

Taking it back to the bare essentials, due diligence is important because it potentially lowers the adventure of you losing your coin.  Due diligence tin lower the chances of making a bad investment, from paying more than than you should for an investment and increase your chances of seeing a return on your coin. However, you can still lose the entire amount invested.

Detailed due diligence provides valuable information that helps investors and founders alike make more informed decisions.

The due diligence process

So, how practise you perform due diligence? The due diligence process tin can be divided into the two components discussed above, being Industry due diligence and Legal/Corporate due diligence, as outlined below.

Industry due diligence means doing wide research. It is vital to come across if there is a market place for the product or service the startup is offering – for case inventing an amazing new fax machine in 2021 might not be the greatest idea.  Brand certain there is  a market place and a demand for the product or service. It is important to recognize the barriers associated with trying to break into a market already saturated with dominant players in an oversupply environment that has already degenerated into a toll-driven competition. Talking to customers, subject affair experts, and company direction is an important function of the process – the more than you inquiry you do, the better informed y'all will be.

Propel(x) goes through a highly structured procedure in their Manufacture due diligence – our in-depth article Due Diligence: The Courage for Successful Angel Investing highlights vii fundamental adventure areas that should exist analyzed for constructive Industry due diligence:

• Market place Risk
• Competitor Risk
• Technology Risk
• Regulatory Risk
• Intellectual Property (IP) Run a risk
• Execution Risk
• Go out Potential

More information on Manufacture due diligence for technology startups is provided in our article Conducting Diligence on Deep Technology Startups .

Legal and Corporate due diligence (or Broker Review every bit it is  known on the Propel(x) platform) on a startup involves confirming they are who they say they are, they have what they say they take, and they can deliver on their projections if all goes according to plan. This requires an in-depth investigation into the company and its founders, including groundwork checks, reviewing contracts, and studying the offering. It includes verifying  the claims of founders who say they accept already raised funds in a electric current circular past checking their bank statements and reviewing financial reports to confirm growth statements are realistic.

Hubble Investments, LLC Broker Dealer registered with the Us Financial Manufacture Regulatory Authorisation (FINRA) and member of the U.s. Securities Investor Protection Corporation, carries out a detailed Broker Review on whatsoever investment opportunity offered on the Propel(ten) angel investment platform . Hubble Investments is owned by Propel(x) and are under common buying and control. These Broker Review reports provide detailed information on the startup such as:

• Company information including concrete address and founding engagement.
• Data about the offering including the corporeality of the raise, the blazon of instrument, and primal terms.
• Documents reviewed such as the term sheet and subscription agreement.
• Corporate structure and buying including certificate of incorporation, number and blazon of authorized and issued shares, stock option agreements, etc.
• People, including background checks and previous work history of the founders, directors, and visitor officers, and review of employment agreements, employee bounty, and agreements with advisors and consultants.
• Concern and operations review including premises endemic or leased, any litigation history, insurance cover, and confirmed contracts.
• Intellectual property status such as patents issued, patent applications, IP ownership, or IP licensing.
• Financial information including review of bank statements, financial reports, audit findings, outstanding debt and liabilities, cash position, financial projections, intended employ of funds, and engagement of accountants.
• Licenses, permits, certificates, and tax compliance.

However, you should still do your own independent review before investing. Beneath is a sample of what a Propel(ten) Broker Review looks like. Company information has been camouflaged to maintain confidentiality.

For a downloadable copy of the broker review, please contact us at marketing@propelx.com

Reasons for due diligence

While startups are not in the business of defrauding people, they are by nature optimistic. So, it is important to be realistic and to determine if  their forecasts are potentially doable. The primary reasons for doing due diligence are:

• Reduce the potential for yous to lose money on an investment.
• Help you identify investment opportunities that may accept a higher chance of success.
•  Help you determine an appropriate amount for you to invest if you do make up one's mind to commit.
• Increment your level of understanding in an investment.

Costs of due diligence

The costs of due diligence vary depending on the scale and complication of the company and the investment. In that location are costs associated with groundwork checks, consultants, advisors, lawyers, and accountants to review the visitor, plus an investor'southward ain fourth dimension.

This is an area where using a Broker Dealer platform tin can provide advantages. As per FINRA regulations, Hubble Investments carries out a detailed due diligence assessment on all the opportunities that are closed on the Propel(x) investment platform. This means Propel(x) members become the benefit of all that research, time, effort, noesis, and experience without having to pay for it in advance – they only pay if they make up one's mind to go ahead with an investment (when it comes out of the investment fee structure).

A cautionary tale of a due diligence neglect

The costs of doing due diligence are discussed above, only what about the costs of not doing due diligence? Consider the infamous case of biotechnology company Theranos.

Founded by then 19-twelvemonth-old Elizabeth Holmes in 2003, Theranos was established on an idea of running blood tests using new car technology that required but a finger pinprick of claret to quickly detect a range of medical conditions. An SEC press release from early 2018 shows Theranos raised more than Us$700m from private investors. Co-ordinate to a 2015 Wall Street Periodical article , Theranos at its summit was valued at US$9b.

Merely everything came crashing down in 2015 when the technology claims of Theranos were finally questioned in depth, which finally culminated in the company closure in late 2018.

The SEC press release from early on 2018 stated that the SEC charged Theranos, its founder and CEO Elizabeth Holmes, and former President Ramesh "Sunny" Balwani with raising more than than $700 meg from investors through an elaborate, years-long fraud in which they exaggerated or made imitation statements about the company's technology, business, and financial performance. The complaints allege that Theranos, Holmes, and Balwani made numerous false and misleading statements in investor presentations, product demonstrations, and media manufactures past which they deceived investors into believing that its central product – a portable blood analyzer – could conduct comprehensive blood tests from finger drops of blood, revolutionizing the blood testing industry.  In truth, according to the SEC's complaint, Theranos' proprietary analyzer could complete but a modest number of tests, and the company conducted the vast majority of patient tests on modified and manufacture-standard commercial analyzers manufactured past others .

The Theranos trial began in September 2021, with Ms. Holmes and Mr. Balwani facing fraud charges that could potentially result in a 20-twelvemonth prison sentence.

High profile people and experienced investors alike were taken in past the Theranos story to the tune of $700m. A thorough, detailed due diligence process might have saved them a great deal of money. Nonetheless, no amount of due diligence can prevent fraud or total loss of master.

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Source: https://www.propelx.com/blog/the-importance-of-due-diligence-when-investing-in-startups/

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