Rebel Venture Fund Reflections — Part 2: Due Diligence

Compared to other investors writing $25,000 checks, our due diligence was thorough. Very thorough.

At times, the information we required would lead to responses such as, “What? Nobody has ever asked me that before.”

As capital has become commoditized in the startup world, less and less due diligence is being performed. If we were a $20M fund writing $25,000 checks, solid due diligence wouldn’t be much of an issue; but we were not, and it was.

The Due Diligence Process

All of our deal flow was managed through Gust. If you wanted to apply for funding, it had to go through Gust. Period. In Gust, we performed preliminary due diligence to gauge whether we were interested in meeting the entrepreneur. If yes, we invited the entrepreneur to pitch to the team; if not, we sent a relatively friendly rejection letter.

Next up is the pitch. You know how it works. Entrepreneurs talk and we ask questions. The usual. If we confirmed our interest, we would schedule a time to meet the rest of the team, closely examine the product/service, and see the entire operation. Though all of these aspects are important, we mostly wanted to spend more time with the leadership team.

Startup investing — especially at this stage — is primarily about placing smart bets on people, not products.

If I could go back, I would mandate that we spent time with entrepreneurs outside of the typical work environment (preferably over beer). I’ve built many relationships this way, and startup funding shouldn’t be any different.

For reference, we had an extensive due diligence checklist, which the legendary Bill Payne personally provided when he taught us his methods. We obviously weren’t going to check off every single point on the checklist, but it helped us ensure that we did not forget to research important topics, especially when it involved legal matters.

After thorough due diligence and relationship building, the final step was for us to present our due diligence report, including a presentation, to our Management Board and Board of Advisors, which were composed of experienced angel investors, venture capitalists, etc. If the Rebel Venture Fund’s report included an investment recommendation, the Management Board would vote to approve our recommendation.

We performed impressive due diligence, so the Board typically agreed with us. However, the Board often brought up great questions that we may not have fully investigated (my favorite leaning experience each month), so additional follow-up due diligence was required before the investment was officially approved.

Once approval occurred, we disbursed a check directly to the entrepreneurs, right?

Not so fast!

Giving $25,000 to a rapidly growing and high spending startup will do absolutely nothing by itself except pay for a few salaries and buy tequila shots on Taco Tuesdays for a month.

For both the entrepreneurs and us to succeed, the financing rounds usually needed to be at least $300,000. Consequently, our deals looked like this:

We will give you $25,000 for X percent of your company, which implies Y valuation, once you close an additional Z amount of financing at Y valuation, which we both agreed is the right round size for your company.

When you look at the Rebel Venture Fund portfolio, what you won’t see is quite a few deals that never made it to the finish line. For a multitude of reasons, entrepreneurs we liked were not able to close their desired financing in time to receive our investment.

As much as I would love to discuss a few specific examples, I have to respect the anonymity of all parties involved.

“Rebel Venture Fund Reflections” Series:

Background Information

Part 1 — Deal Flow Generation

Part 2 — Due Diligence

Part 3 — Recruitment