Learn how to do DD like a startup founder with these 66 checks (and learn how to spot shams)
So apparently my new thing is writing blogs on planes. Planes are good because no distractions and wine. People who know me know that I am quite vocal with my opinions and often suggest I should write a blog based on some of my ideas. My last one was on hiring interns.
Why this topic? I feel specifically in Australia that because startups are relatively ‘new’ 90% of people involved have literally no idea how to tell what is legitimate and what is a sham. Obvious one being journos, who seem to be happy to take the founders word as gospel. I know these people are very short on time, so maybe this will help. From what I read the US startup press is better at startup analysis. In generally I hope this article will help people filter out the shams and focus on those doing good work, and there are lots of both in Australia!
These checks are focused on determining the true status of the startup rather than ‘is the market big enough’ type questions which a typical investor would ask.
Now before we start let us be clear this is mostly applicable for B2C, B2B is very difficult to do due diligence (DD) on without talking to the ‘clients’. A B2B startup could be killing it and not even have a website. Actually this is what makes B2B startups so dangerous, unless you can actually speak to the clients you are basing your DD purely on what the founder is telling you.
Founders are generally slightly delusional and for good reason, they have taken huge risks and poured a chunk of their life into a project. They will say what they need to, this is known as hustle aka fake it till you make it aka white lies aka bending the truth aka omitting certain pieces of information.
Because everyone else is doing this, you need to as well, and for this reason I feel I am qualified to write this article!
Some basic rules:
- Assume everything is probably false until it has been substantiated;
- Any numbers or metrics quoted are probably at the maximum they ever were;
- Part of what you are trying to spot is lost founders, the business could still be based on an awesome idea with a massive demand;
- These checks should be used to help startups, as I mention the fake it till you make it culture often pushes people to the point of outright lying.
It’s probably also worth saying that when a startup pitches to an investor, they want you to be good. They want you to be their next deal, they are probably as desperate as you are for investment but for their next deal. But they also don’t want to get burnt. This article is not written for investors specially, but considering a few of the startups I have seen funded over the past 2 years, some of them could have seriously benefited from this article and saved a tonne of time/ investors money.
Let’s get down and dirty into the checks. You need to pick the ones that are relevant to the business.
Cautionary note: This is NOT designed to be a DD checklist for startup founders, or investors, it’s just meant to help people understand the status of any startup!
General Situation aka The basics
Basic checks which help determine the true status of the business.
1) Search for them in Google
If they don’t show up then it’s either very early stage or they chose a poor name which is not unique, not a good start.
2) When was the domain registered?
Founders will typically register a domain quite early on in their journey, sometimes even years before formally starting. Conversely if it was registered last week it is either a pivot or they thought of this idea in the pub with a few mates last week.
If com.au then it will have an ABN: http://abr.business.gov.au/
3) Are they incorporated?
If not then it’s early days, the founders still haven’t worked out equity, not a bad thing, just worth knowing.
4) 5 minute landing pages
Eric Ries is probably face palming daily after he kicked off the landing page MVP, yes it is a thing but it has been overdone and it now only takes 5 mins to an hour to set up. If their website is just a landing page collecting emails (more on this later) there is nothing wrong with this, but just be aware it could have been set up in the time you read this blog post.
The same also applies for what I would call a fancy landing page, i.e. they have an About page, Team page, FAQ, Press, &c. This probably another 2–3 hours work and is meaningless.
5) Is there even a product yet?
Does the product actually exist yet? Is there a beta version available (try beta.website.com or testing.website.co), email them and ask to test it if it is not public, if they say no then it’s not ready or non-existent.
6) Are there users yet?
Just because there is a live website/ app/ platform doesn’t mean anyone is using it. This is easy to check with market places or social networks. For example I checked out a certain neighbourhood social network a few months ago and my closest ‘neighbours’ were in suburbs over 5km away 😬. Maybe it’s better now, social networks are hard!
7) Are there paying customers yet?
Easy to tell, can you find a way to give them money?
8) When was the first mention in Google?
Google related terms, founders &c., similar to the domain check above. When you find out the startup has been going since 2006 but only just launched in 2016 then something is adrift.
9) Is this a re-invention of a previous business/ idea that founder is obsessed with?
Not necessarily a bad thing but something to note, some founders don’t know how to kill an idea.
10) Is this a clone of a similar business in the US or elsewhere?
For some Aussie investors this seems to be a plus(?!) but a big problem with our ‘innovation’ here in Australia is a lot of it is just looking to what is trending overseas and not thinking for ourselves.
11) Time from full time to launch, if more than 6 months then warning signs?
Unless proven via a previous business, some founders are scared to launch as it means getting their baby no one wants out into the public, your data points from above should give you a good idea of this timescale.
12) Is founding team full time? What % of staff are full time?
An embarrassing number of Aussie startup ‘founders’ are not working on their projects full time, as an investor this should be a serious warning sign 1) They are unfortunately not in a financial situation where they can invest their own time, meaning they need your money for salary or 2) They don’t believe in the business enough.
Ideally you want 2–3 founders, and those founders to be full time 👊.
A founder friend of mine recently told me he had 70 staff, turns out there are actually just writers for a content site, mostly working on a per article basis, this is a bit like Uber calling each of their drivers staff.
13) Overly large or ‘Rock Star’ Advisory Board
Be very sceptical of team slides/ pages, founders feel they are achieving something by hiring big teams of people who work 2 hours a week. The same goes for boards, no business ever succeeded just because they had big names on the board, in 99% of cases this is no more than a name and they might be vaguely giving the founder advice/ intros in exchange for equity, and attending a quarterly board meeting.
14) Was there an MVP, where is the validation?
Can you see evidence of an MVP? Aussie startups are not good at validation and many still follow the ‘just go build it’ approach without testing if there is a demand. Usually one has to talk to the founder to find this.
15) Why did the founder start the company?
One would need to ask the founder this, or find an online interview. Why did they start the company in the first place? I know people who discovered an accelerator was open for applications and then thought of an idea as an afterthought….
Try and determine if they actually experienced the problem first hand of if they ‘thought it was a good idea’.
Checks on the founder, why are they doing this in the first place?
What were they doing before? Doesn’t have to be relevant but they should have at least experienced the problem they want to solve. If they are a coder what have they built, do they have a github account. Did they just do a 12 week GA course on UX and now they are a ‘UX guru’?
17) Fake roles, e.g. Google Consultant
Is their CV legit? Look at LI and try to read between the lines re fake it till you make it. Recently I came across someone who claimed to have worked for Google, turned out they were a ‘Google Consultant’, whatever that is. Anyone can list whoever they want as an employer in Linkedin.
18) Previous startups aka projects
Common problem with people bitten by the startup bug is that they are so desperate to do a startup they flit from one idea to the next without doing any of them properly. They are more excited by the role than the business. Just search if they had a ‘startup’ previously, and how many.
19) Cereal entrepreneurs
Same as above, if someone is genuinely a successful ‘serial’ entrepreneur they probably wouldn’t be asking you for money or help right now.
20) Where do they live?
Yes this sounds stupid but you’d be surprised, are they actually in the place you think they are full time?
21) Life situation
Mostly for potential investors but worth knowing: are they single, married, about to have kids, just broken up. Don’t discriminate but important to understand what is going on outside of work.
22) Still studying?
Further to above quite a few founders are still in uni with 2–3 years left, they have the startup bug which is awesome but it might be too early.
23) Do they have any other startups?
Again sounds surprising but I have met a number of founders who claim to have multiple startups, they should barely have time for one.
How to smell a dodgy cap raise vs a legit one.
24) Back door
A weird ASX thing that will hopefully die soon, startups claiming they were acquired, IPO’ed or just raised $Xm whereas actually a 2 man West Perth mining company run out of some dudes shed with $3m left in the bank has found a new use for the remaining capital. The startup inherits the old board who are ‘tech experts’, the $400k annual fees associated with being listed, and the CEO is being paid $200k. Everyone on the board is happy because they get to earn their compensation again. The only ones getting burnt here are the previous shareholders or any new ones who were swindled into purchasing new shares. This isn’t always the case but sometimes is.
25) Round not closed yet
Is this the announcement of a round or did it close? These journos are short on time so be careful what you tell them!
26) Personal money?
Nothing wrong with this, actually it could be a good thing, but some rounds are actually the founders cash or sometimes they are valuing their equivalent time at $X salary. This is correct in a sense but it is not a ‘raise’.
27) Founder not willing to take any personal risk
‘I want to do a startup, but I don’t want to take any of the risk associated with it, can I have some money now because my lifestyle costs $100k per year’.
28) Is part of the raise debt, or even revenue?
I know what you’re thinking… WTF. But yes some startups are claiming ‘rounds’ that are actually revenue or just a one off consultancy project.
29) Is founder just extremely good at raising?
Notorious with ex-finance people. They are very good at sales, have a solid network, and what looks like a good track record (because finance experience = good founder…). In reality this is terrible because at some point they need to build a real business and that requires getting your hands dirty.
30) Who is building the product, is it being outsourced, is there a CTO?
Try and figure out how the product is being built, look at Linkedin for dev employees or a CTO, then do the checks above to see their background and status. If none then you may have a non-tech founder using an outsourcing agency = high chance of serious cash burn and death.
I am quite vocal in being against outsourcing for tech startups because 1) their drivers are wrong 2) development never stops and 3) you won’t learn as much.
31) Is there a beta or pre-launch version?
Mentioned above but usually a good sign that the team is open to early feedback lean startup style rather than too scared to launch. Just ask them!
This is super important, it’s quite easy to gauge website usage and get an idea of what traffic volumes they are really getting.
It may be based on a dodgy browser plugin that is being used less and less everyday but at least that means the results are sketchy for everyone. It works well relatively. Use it to compare a site to a competitor or another site you know has real traffic. New/ small traffic websites don’t really work on here but if a website has even the slightest hint of traffic it will show up.
Alexa also tells you basic stuff like bounce rate and return visitor %age, which is very rough, but gives you an idea of whether users are returning or not.
33) SEM Rush
Expensive but you can tell quite a lot from a free search or 14 day trial and a mailinator address. Do they understand SEO, what are their channels, does this line up with their pitch? As an example for Simply Wall St the data from SEM Rush is in the right ball park. Compare it to a competitor.
Very hard to tell, best to ask the founder. Ask about returning MAU not MAU or whatever period they use. Can get a rough idea from the above.
35) Site content, market places, public metrics
There is nothing wrong with seeding, all marketplaces need to do it when they start. But you need to figure out if the users/ profiles on the site are:
- Real vs imported (common to scrape other sites to create profiles)
- Active (try sending one a message)
- Growing (check a cached page from a month ago, is it the same, then growth is fake)
36) Ambassadors/ Evangelists
If the product is really good, the web should be awash with people talking about it, this could be social, reviews, or even just mentions in articles.
Check if they have a referral scheme (e.g. the SWS one), and if they do search online for that URL. This gives you an idea whether the product is good enough for people to actually bother doing referrals.
37) Use Wappalyser
Quickly see what a website is built in using Wappalyser. If you’re not a techie get a friend who is to look, you can learn a lot. If the site is Wix, Squarespace or Wordpress then see my point above on landing pages.
Apps are great, when they work. But we aren’t in 2005 anymore and getting noticed on the app store is a tough gig, my personal opinion is that many startups would be better off just building a great responsive website.
38) No. downloads
Easy. If a startup says they have 50,000 downloads but the sum of the downloads on iTunes and Google is 100, its balls. You can roughly extrapolate downloads from reviews if the number isn’t quoted and the reviews aren’t all fake.
Typical app metrics which might be surprising to some (may vary…):
- Installs to open ratio(also known as app units on iTunes): 50–70%
- Active users vs installs: 2–50%
- Reviews per download: 1 review per 100 downloads
Result: Installs != to active users!!!
39) No. reviews (can be fake)
Fake reviews are a big thing, if the number of reviews is very high but low number of downloads, then you should be hearing warning signs.
40) Bad reviews
Not much to say here, are they even replying to the bad reviews? If not then walk away, very concerning.
41) App analytics websites
Have a look at things like AppBot, AppFigures &c. to get a good idea of how the app is trending on the stores. Remember an app can be getting amazing usage/ engagement with not many downloads or not being highly ranked on the store.
42) Actually use the app!
Actually download the app and use it!!! Apply what I mentioned with websites. I don’t personally take meetings with people who haven’t used SWS.
Growth aka Marketing
Do they understand growth, is the growth real?
43) What are their main channels?
Use SEM rush to get a rough idea, do a Google search to see if they are running ads, likewise for FB. How are their social feeds, are they doing content?
If a founder tells you they are going to attract users by social, ads and content marketing, this is a bit concerning, because it means they haven’t really spent much time on growth.
44) Do they have a growth framework?
Would need to speak to founder or might be in the deck, if a startup hasn’t figured out it’s growth framework yet, it means they are at an early stage. Until the framework is set measuring the performance of different growth initiatives becomes difficult.
45) Are they advertising?
Dirty unless late stage or with proven CPA/ LTV metrics. Common with funded startups who want some metrics that go up and to the right.
46) Are they spending money on ads to collect emails?
Conversion from email list to active user is notoriously difficult, one startup I know had an email list of 5,000 pre-launch that converted to 1 actual sign up! This screams of poor understanding of marketing and not valuing capital.
47) Ads without a paid product?
Means they have a very poor understanding of growth and also enjoy burning money. The main concern is why are they not spending the money to test unpaid channels first?
How many high growth startups do you know that used ads to grow in the first 2–3 years?
48) How diverse are their channels?
Are they super dependent on a single channel, is this a risk? (more of an investor concern)
49) The state of their content marketing
Content marketing is an insanely powerful channel when done right. It was easy in 2010 but now it’s super competitive and a waste of time unless you are doing better than all your competitors.
There are a few possibilities with content marketing:
- Epic content + extensive distribution channels = GOOD
- Generic content + extensive distribution channels = Potentially good
- Epic content + poor distribution channels = Distribution is harder than content IMO!
- Generic content + poor distribution channels = Not good
50) Content marketing without any real understanding?
Classic mistake. Founders spending time writing our outsourcing blog posts which get 10 reads, 8 of which are from friends, not good use of time and means they have no idea why they are doing it in the first place.
I know I say this as I write a blog post on a plane, but in this case I’d just be watching a movie instead and its quite fun🙊.
51) Desperate or untargeted PR in hopes of referrals, e.g. startup founder talking about something irrelevant to the business
I personally don’t like PR, I know it has worked well for some startups but generally it’s out of most startups control, takes a lot of effort and only lasts once. It leads to annoying bumps in your analytics. A good way to spot an inexperienced founder (I was/ am one) is someone who thinks getting into the press will solve their growth problems. I’ve formed my opinion on PR by actually getting into quite well known publications and seeing the results (not that good).
Now what is even worse is founders who think that becoming a ‘thought leader’ will result in significant user sign ups. This is much harder than it sounds. One is assuming that the people with the problem you are solving are also reading the publications that cover the same topic. An example for SWS would be me becoming a fintech thought leader, but turns out most of our users don’t even know what fintech is, they just want to invest better. I can get heaps of user signups from getting into the press talking about fintech, but those users are of a low quality and convert badly.
52) Collecting email addresses as part of a vanity metric
Everyone knows about vanity metrics, but even worse is vanity metrics than can be gamed by external factors. An example is a certain investment platform who recently purchased a certain investing newsletter and added ~700k email addressed to their ‘user base’, how many of these do you think are active?
The holy grail of growth, without retention everything up to this point is useless as the users will disappear anyway. If you are confused by this then watch this video. Perhaps conveniently for startups retention is quite difficult for an outside to measure, so it is best to grill the founder about it. It is possible to estimate retention if you know a combination of other metrics.
This part is the most B2B specific. Partnerships are useless in 99% of cases, and difficult for an outsider to verify. Again the aim of this is to discover good partnerships, they do exist!
The only thing that corporates love more than hiring consultants is partnerships with startups. It makes them look and feel all innovative. In the corporate world innovation is regarded as a sort of STD that rubs off on people. In all seriousness corporates love to partner with startups because it keeps the board and investors happy, it’s an achievement that is very achievable but means nothing.
I am also speaking from experience. We ink’ed a partnership with a certain large Aussie bank, that in the end it fell through. People still ask me about it regularly, 0 users.
53) What is actually involved? Did they just sign an MOU?
Ok so what does the partnership actually involve, how many clients/ users are involved, when will it start, has any money changed hands?
54) Marketing stunt
Look at it from the outside, a startup will never say no to a corporate (and the PR), look at the last few investor presentations/ reports from the corporate if listed, do they mention partnering with startups as a goal?
55) Is founder good at signing partnerships
A bit like raising capital, some people are just good salesmen. But this needs to translate to actual work otherwise it is useless.
A famous founder distraction activity and one of the more irrelevant metrics of all time but hey, at least it is easy to evaluate.
56) No. likes/ followers, are they fake?
Everyone knows number of followers is a useless metric, unless the startup uses the network as a major channel and it is working. What you need to look for here is the opposite, do they have a high number of followers but for no reason? Choose 10–20 of them and look at the profiles, are they real people? Followers are cheap.
57) Likes/ Post ratio
Look at the past posts and see what the average number of likes per post is, then compare that to number of followers. If they have 400k followers but each post only gets 1 like, something is dodge. Likewise if each post gets the same 4 likes, also dodge.
58) Do they speak the same language as the startup?
A really easy check, sometimes hilarious, if a startup has paid for followers often they will be in a different country. So they get comments on their posts like ‘this app just like facebook’ or ‘I earnt $6,000 last week from home’.
59) Are they getting shared/ retweeted?
Still easy to fake, but a good measure of real engagement if the people sharing posts are real. You want to look for real evangelists.
A bit like bad reviews, a few Aussie startups have users complaining on their FB page, which isn’t a good sign but at least it means they have users!
Where’s the money Lebowski??
61) Real source of revenue
Hard to tell without seeing the books but what is the source of the revenue? Some startups will claim revenue but on further investigation it is not coming from the main product. A typical example is consultancy, the founders are probably experts in one area, people want to pay them for advice, but this has nothing to do with creating a scalable product.
We won a Citibank contest in 2015 where we received $35k as prize money, this was awesome but it’s not real revenue!
Another common ‘trick’ is to include the amazing Aussie R&D tax rebate in your top line, if your startup is burning $500k+ a year on dev work then this number can be quite significant!
62) Real revenue vs Equivalent Annual Revenue
Best example of this would be a startup offering their product at a discount (many do, like us), but then quoting their revenue as no users x the full amount.
63) 80/20 e.g. $500k revenue but $250k from one client
The 80/20 rule, not necessarily a problem but worth knowing. Has a large chuck of the revenue come from one place or one client?
64) Cash flow that is not real
An example would be “$Xxx million of loans loaded onto the platform”, but if a ‘loaded loan’ just means someone typed a number into a textbox a pressed submit, it doesn’t mean a great deal.
65) Burn rate
The big one. Startups that are pre-launch, pre-raise or whatever but already have horrific burn rates. Usually from the founders paying themselves too much which in translation means they don’t really believe in the business in the first place. Until a company is breaking even founders should be paying themselves the minimum they can to stay alive and the rest should go back into the business.
66) Cap table/ Who owns the shares, do core team have equity?
Very hard to find for startups but investors would see it quickly, does the core team have reasonable equity. Are there any dead weights on the cap table? Does the founder and core team have enough equity to stay motivated? Are there founders with low single digit equity?
If you can think of any good checks I’ve missed then comment below and I’ll include it.
In total the checks above would take quite some time to execute, and I don’t recommend using them as the basis for a DD checklist! But if you select the relevant ones you can quickly get to the bottom of what status a startup is at, and then it is up to you to help them from there!