TLDR:
- Due diligence in venture investing is making a comeback after the quick and less thorough processes of 2021.
- Investors are now focusing more on high-quality diligence, which involves thoroughly evaluating opportunities and developing high-conviction investment theses.
According to a study of 700 venture capital firms, a typical deal once took 83 days to complete, with VCs spending 118 hours on due diligence and calling 10 references. The rushed processes of 2021 led to compressed cycles and increased down rounds in funding. However, as interest rates rose and capital contracted, the importance of thorough due diligence became clear.
Diligence in venture investing aims to thoroughly evaluate opportunities and develop high-conviction investment theses. The “art” of due diligence involves homing in on key issues related to the opportunity’s upside and downside. Factors considered during diligence may include founders, competitors, market dynamics, technology/IP, financials, operational metrics, regulatory risk, governance, cap table, and deal terms. Investors also conduct reference calls and backchannel checks, spending time validating the startup’s strategic overlap with their corporate parent.
Early-stage investing focuses on factors like founders and market potential, while later-stage investments resemble private equity deals with detailed financials, revenue breakdowns, contracts, corporate documents, and IP portfolio. Corporate venture capital firms prioritize strategic overlap with the parent company, considering product portfolios, R&D collaboration potential, cultural fit, and other factors.
Successful diligence mitigates risk for both investors and founders, providing valuable insights into a business and its future challenges. In 2024, investors are reemphasizing the importance of high-quality diligence to avoid the pitfalls experienced during the funding frenzy of 2021.
