Investment Process: Due Diligence Is like Dating Before The Marriage, Says Paolo Limcaoco

Due Diligence (DD) is an inevitable part of an investment process. In the VC parlance, DD is about the investor and the startup getting to know each other and getting into a comfort level. DD is a long process and often takes weeks or months to complete.

In this episode of e27‘s Fundraising Fundamentals webinar series, Paolo Limcaoco, Investment Officer at Accion Venture Lab (a fintech VC firm), talks about the three aspects of the process.

Below are the excerpts from his session:

DD is about investors getting to know the startup. This is done mainly on three levels — team-level, operations/business model-level, and the financials-level.

1. Team

The very first level is obviously getting to know the team (founders). It is almost like going on dating before you enter into a long-term marriage. You need to get to know each other before the big days. Because once you invested, it’s very difficult to get out of it, and you have to make sure that your partnership works. Of course, there will be disagreement between both parties.

DD can go both ways. While investors do diligence on companies/startups, founders are also expected to perform their diligence on all investors they are speaking to.

It is very important that you guys get to know each other, the values and mission of the investors, their time horizon, as well as about their other portfolio companies. You should try to learn as much as possible about the investors.

By investing, we — as an early-stage investor — are basically making a bet on the founders and management team. It is potentially an early product, early traction and early product-market fit, and we don’t really know how it’s gonna play.

In normal times, what we would do here is spend a couple of weeks on the ground. We talk about a variety of topics, including the business model. We also conduct greater reference checks on the founders by reaching out to our common contacts on LinkedIn, our co-investors and also other founders in the ecosystem.

It is not just that we gain value only from meetings with the founders but we also interact with their employees in the office in person.

During the pandemic, we do Zoom calls, Google Meet or even WhatsApp calls with the founders and their business partners. So it is more about scheduling calls and spending time with the founders and the management team.

2. Operations.

Here we check whether the company has a product-market fit, how innovative and differentiated their product is and if they are able to acquire customers — everything that revolves around the operations of the business.

We look at the high-level macro trend to understand what’s happening on the macro side.

If it is a company that’s working with small merchants/businesses/ individuals, we try to meet them. We will also try to meet their distributors/customers/clients. So it is worthwhile thinking about how to bring your customers, products and services closer to your investors.

Another key aspect is obviously the product and technology. So aside from really trying to understand how it works, we try to understand the front-end and back-end operations. We will normally have a tech call with the founders or CTO, alongside a couple of members from our Venture Lab team, and try to understand the process.

3. Financials

We need to ensure that a company’s financials make a lot of sense on the business side. You may not be making any profit yet but in the long-term, the forecasts and economics must make sense.

Because in the end, a lot of businesses survive a long time without making any money. It would be good to at least have an idea of how the company will get to scale. So the financial due diligence is quite important.

It is really about us getting comfortable with the assumptions of the business model and the things that you’re presenting.

When we make an investment, we will definitely look at the similar companies we have invested in in the past. For example, when we are looking to back an SME lender, we can take a look at some of the learnings that we have made from investing in other markets and will try to validate if the assumptions/forecasts make a lot of sense.

It is also very important that you’re able to back up the assumptions. We have seen companies trying to make the numbers look as nice as possible but in the end, there has to be some backing to it.

Normally, we do take those with a grain of salt and are trying to look at more how to be on the more conservative aspect of things.

So, so, yeah, so we make sure making sure that, you know, when you present financial models, your assumptions are solid, clear, and have some level and some level of backup there.

Source: e27