Our approach to Due Diligence for Early Stage Companies
How it serves you as founders and us as an early-stage VC
by Björn Loose, Principal at Cavalry Ventures
We have to start this post with a little bit of a bummer: There is no money-back guarantee in venture. Sorry, if this caught you off guard!
Venture Capital is not a consumer product. Once we sign an investment agreement, we enter a long-term relationship. We will be working with you for many — hopefully successful — years.
I cannot stress enough how important it is to diligently look at the venture firm that you are looking to partner with. We do the same and want to use this post to provide you with selective insights on our due diligence. While doing so, we shed light on the ‘why’ and provide some background on our thinking. Ultimately, we use the process of a DD to get to know you and to be able to provide you with the support you need so that — even though there is no money-back guarantee — you will be happy as a founding team.
The process of a DD serves us as the crucial point of getting to know a team, company, and market well enough to be able to provide adequate support later on.
When I went through the results of Atomico’s report ‘State of European tech 21’, it was interesting to see the effect of increasing competition between venture firms across all stages. Respondents not only mentioned increasing valuation or inflation in funding volume but also lighter due diligence when considering an investment.
This got me thinking: Yes, you need to be nimble in today’s market. But seriously, sacrificing DD efforts cannot be the answer. Pre-empting DD efforts, i.e. doing most of the job prior to starting a process with a team, is a strategy that has been successfully adopted by numerous funds, among others by Tiger Global and Coatue, to find a more competitive position. However, lighter DD efforts will not only have a negative impact on the fund’s selection but also a negative impact on the support that this fund is able to deliver. Let me outline the latter.
To us, the process of due diligence serves as the crucial point of getting to know a team, company, and market well enough to be able to provide adequate support later on. Let’s focus on a few tangible examples.
Reference Calls: How we find out more about the personality behind the person
When initiating a reference call, a lot of people that we contact are surprised when we don’t ask them about the classic strengths and weaknesses of a former coworker. While we acknowledge their importance, we generally try to use reference calls to learn in much more detail about the character and skills of a founder that we are looking to partner with.
Questions include: Who will I actually be working with? How can we support this individual in the best possible way? How can she or he be most productive? And most importantly: How can we complement her or his team in the future?
This way, reference calls will not only yield more insights but are also a great tool to set us up for future work with the founding team.
Transparency & Collaboration: Kicking off our mutual engagement by sharing insights and market research
One dynamic that we have observed is that market research is being shared with founding teams by an increasing number of investors. I’m very supportive of this and would encourage everyone to do the same. Obviously, it is nearly impossible to build as deep of a vertical expertise as the founders themselves. It’s not the expectation of market research to arrive at this point. In fact, the way a team approaches a market from an operational perspective may be quite different from the investor’s view. However, there is still value in additional data points for founders to take into consideration.
What is important to us is that due diligence efforts do not end once the ink is dry. Consider the DD as a good starting point to familiarise yourself in detail with the market, industry dynamics, competition, etc. On our side, we continue to talk to industry experts, potential customers and business partners regularly after our investment and oftentimes repeat parts of our DD efforts to better understand the latest developments in the market or anticipate market dynamics. Only then, we can have informed discussions with the founders.
Continuous support is key
Unfortunately, we are seeing too often that investors contribute most to a business when they are trying to win a deal. Be aware of investors that signal relevant industry contacts, promise to introduce potential customers but do not follow up. Once invested, sometimes there is little more than silence.
It is encouraging to see that European VC is professionalising and we as well try our best to set the bar high. While we obviously position ourselves competitively in an investment opportunity by signaling relevant access, the default must be continuous support.
Since speed is of the essence for early-stage companies and runway is limited, we initiate contact with our subject matter experts already prior to signing the documentation of the funding round. Founding teams typically start working with our team of experts in the fields of Talent Acquisition, Communications, Legal and Finance already prior to signing. This way, founders are ready to put the capital to work once the money from the financing round hits the bank account. At the same time, our colleagues get an impression of the founders as well. Thus, the subject matter experts are able to provide additional feedback and further insights for our investment team.
Once the money is wired our work is only starting. Over time, we mapped out a clear process on how to onboard and continuously support our portfolio companies. We share best practices, we provide you with frameworks on KPIs or OKRs, we sit together and iterate on your business model, hiring strategy, employee incentive schemes, product roadmap or go-to-market strategy, etc.
What a DD process actually means for us
As you can see, we approach certain steps in our due diligence process with a particular view on our relationship with you as founders. Rather than approaching the DD as a tool to find ‘red flags’, we use it as a tool to build a granular understanding of your team and the business in order to build a solid foundation for future support.
Dear founders, even though we cannot issue a money-back guarantee, we will make sure that you are in fact happy with us. If you aren’t, let us know and we’ll listen carefully. To make it easy for our portfolio companies, our platform team has set up a ‘post-investment survey’ with the constant goal of learning more about what the founders in our portfolio need, to iterate and improve our processes. As suggested at the beginning: We cannot stress enough how important it is to diligently look at the venture firm that you are looking to partner with. Don’t take our word for granted. Just ask any founder we’ve ever partnered with.
