Investing in a Startup? Invest in Due Diligence First

Today, investors have numerous opportunities available at all times if they are on the lookout for a business to invest in.

Awareness and growth in the Indian business community, the liberation of barriers to capital formation and the pace at which startups are coming into existence today are some of the many reasons for availability of this wide range of choices.

Due to the extreme competition prevailing in various industries, it is more toilsome than ever for investors to choose a promising and competent business out of the innumerable options that galore.

However, to overcome this dilemma, a procedure called ‘due diligence’ has entered the world of startups and startup investment.

Due Diligence: Meaning and Importance

Due diligence means investigation and evaluation of the concerned startup.

Undertaking due diligence is necessary to help the investor take informed decisions about investments, potential returns, and other related matters.

Under due diligence, the entire life of a startup is brought under scrutiny which enables the investor to obtain an in-depth understanding of the company, its technology and management, future business models, and investment potential.

Since investing in startups is an inherently risky enterprise, it is important for an investor to undertake due diligence. It enables him to assess a particular proposition and calculate the expected rate of return.

A sound understanding of assets being acquired and liabilities being incurred certainly does more good than harm.

The fact that 75% of startups eventually fail makes evaluating their economic viability all the more important.

Due diligence is also beneficial to the investor because only those startups which are considered worth the time, money and risk involved, are scrutinized thoroughly.

There is no strait-jacket formula guiding start-up investing, but some fundamental guidelines should be adhered to eliminate risks and to avoid foiled investments.

Due Diligence: The Process

Due diligence is a structured process evaluating investment opportunities against an established standard and involves various phases.

The initial phase of the screening process includes a detailed inspection of the particular product or service of the firm, the founding team and the industry within which the company operates.

The second phase involves a thorough assessment of the specific market that the company plans on targeting.

The third phase focuses on assessing the revenue generation capacity of the firm.

The fourth and the last phase culminates into a review of material facts and figures, leading to a final decision.

Due Diligence: The Legal Aspect

Legal due diligence is also an essential part of the entire procedure. Once the assessment of the company starts to move in a favourable direction, the investor’s lawyer conducts a complete legal review of the firm.

The entrepreneur/startup founder should ensure that his lawyer is competent enough to answer all queries of the investor’s lawyer satisfactorily so as not to curtail the firm’s chances of procuring funding from reputed Venture Capitalists or individual investors.

Caution and a little discernment go a long way in ensuring that the investor chooses an investment option that is dependable and advantageous

Some More Tips to Help You Invest Wisely

To ensure minimum loss and maximum return on investment, some other factors that should be kept in mind are:

  • Looking for partners to split investments, risks and returns is always a good idea.
  • Investing in promising brands with a great product or service, clear cut business plans, and a diligent team paves the way towards a rewarding future.
  • Investing in a vocation that you are enthusiastic about or which is related to your specific area of command/interest makes you a better judge of the company’s present and future, and greatly influences the investment decision.
  • Startups can thrive in one year and fail in the very next. It is wise to keep exit strategies handy to liquidate whatever is possible.
  • If you are new to the field of investing, getting in touch with a due diligence firm that can perform a complete evaluation of the company in question can save you time as well as some adverse experiences.
  • Developing risk mitigation plans with the company as part of the investment is a prudent measure that can further improve the chances of a successful investment venture.

No matter how inconvenient or tedious this entire process is, it plays a significant role in making investment an easier task.

Due diligence exerts a two-way significance on both startup and the investor and ensures a long-term relationship between both parties.

Spending time and money on due diligence is not an expense, but an investment as it enables you to enjoy lucrative returns on your money.