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As we discussed in Evaluating Opportunities, the startup team may be the most important determinant of a company’s success. While you should have gotten a good sense of the team’s potential when you were first evaluating the opportunity, digging deeper into the makeup of the company during due diligence will help you gain certainty on your initial impressions.
Below are a few personality traits to consider. Throughout the diligence process you will likely have multiple conversations with the founding team. Try to assess some of these important traits:
Hustle. Hustle is shorthand for a team’s tenacity, resourcefulness, and passion. The team needs to be able to make decisions and meet goals quickly, overcoming obstacles again and again. In short, they need to be able to execute. Talking to the key members of the team about challenges they have run into, how they solved hard problems, how long it took them to build the prototype or get their first sale, how they convinced their first key hires to take the risk, can all give you a sense of how they are able to get things done.
For example, Pete worked with one CEO who was pulling all-nighters reviewing and negotiating key partner contracts in the early days of his startup, while having his infant daughter strapped to his chest with a Babybjörn carrier. At the other extreme, Pete was mentoring a first-time CEO who kept discussing their vision and the technology research they were doing, but who never built even the most basic prototype. The first CEO built a company and raised over $80M, the latter was never able to turn their vision into reality.
Commitment. Building a successful company requires the ability to work steadfastly for years through sometimes extremely difficult circumstances. The core founders should be committed to the enterprise. They might talk passionately about how they want to change their industry. Try to get a sense of their motivation. You are looking for someone who will stick to it when the going gets tough. Be wary of an entrepreneur who mentions a plan B if this venture doesn’t work out: “If I can’t get this to $1M in revenue in a year, I’ll just go back to work for Microsoft.”
Compatibility. What about the strength of the team bonds? Is the team likely to fracture and break up? Can you sense tension when different members answer questions or discuss challenges or decisions? It’s a good sign if several members of the team have worked together before, as they will know each other’s personalities and capabilities well. If it is unclear from their backgrounds that they have worked together, feel free to ask questions about how they know each other, whether they have collaborated in any capacity, how they became convinced that the other could take on key management roles beyond their existing experience. The breakup of the founding team is one of the leading reasons early startups fail, so don’t overlook this issue.
Coachability. Finally, it is important that a CEO is coachable, especially a first-time CEO. A wise CEO will seek guidance from investors, advisors, and experts in their network. They will face many new challenges and you want them to be willing to benefit from the experience of others. Pete can attest that there is nothing more frustrating than a young first-time CEO who will not heed the collective advice of the board of directors and advisors!
Team Employee Status
In Evaluating Opportunities, we touched on functional coverage of the team, meaning the degree to which the key functions required for success (product development, sales, marketing, customer success, design, finance, et cetera) are represented in the team. The critical functions will vary to a degree according to the type of company, and certain functions will often be outsourced, like legal and often the CFO role.* Beyond those roles, look carefully at who is employed, and who is contracted or outsourced.
The entrepreneurs feel pressure to show a complete team in their presentation, but as you dig in you will often find that there is a mix of full-time and part-time employees or contractors, and even friends chipping in for just an equity stake in the dream. This mix is not uncommon, but you will want to know who you are investing in, who will be full-time when the money is in, and what has been promised to whom.
important It is highly recommended that you interview each of the key team members called out on the team slide (the ones you are investing in), and ask them directly about their level of commitment. You may find that some are never planning on committing full-time. In that case, you have a functional gap to fill on the team, and a potential red flag as to why this person is not excited about the venture.
caution There can be liabilities associated with deferred wages or vague undocumented promises of equity to people who have made contributions over time. Understand the personnel history of the company as early founders or contributors may have already exited, but still own a stake. Furthermore, anyone who is contributing to the company in some capacity should have signed an invention assignment agreement acknowledging that their work is owned by the company. We will discuss liabilities and employee issues in more detail in Legal Due Diligence for Angel Investments.
You should also determine whether the technical development team is in-house or outsourced.* Outsourcing software development teams is increasingly popular among startups because it can be significantly cheaper if the coders are offshore; and because building a good in-house development team is hard, expensive, and time-consuming. For an entrepreneur, it can be challenging to convince a great software developer to commit to an idea and work full-time for little or no salary while they build the first version of a product. It is often easier to find a team of developers in Eastern Europe or South Asia to build the first version of the product for a few tens of thousands of dollars.
caution As the investor, you want to know what you are getting into, and make sure that whoever is managing offshore teams, if that is the case, has done that before. If there is no one technical enough on the team to vet the offshore team, provide architectural guidance, and vet the code coming in, that might be a cause for concern. As the business grows, it will likely have to backfill the technical roles locally, which will take energy and resources.
Reference Checks and Other Third-Party Insights
Beyond interviewing the team members yourself, it is highly recommended to get some reference checks on the team. In addition to checking the references supplied by the company, you’ll want to track down your own. Use LinkedIn to see if you have any way to get an introduction to other people who know them or have worked with them. It is not uncommon for entrepreneurs to amplify the scope of their responsibilities in their last role as an employee. That’s understandable to a degree, since they are trying to convince you that they can be an effective CEO of a soon-to-be-huge company. So it is important to dig in on this.
There are other ways to get some additional information on the founders and key team members:
LinkedIn. LinkedIn provides job history information and also can show references provided by former bosses, partners, or direct reports. Increasingly, LinkedIn is a publishing platform as well, and many entrepreneurs may have written articles about their industry.
Twitter. If team members are active on Twitter, you may be able to get a sense as to whether they are actively consuming articles and commenting with insight on the domain of the startup, and whether they are attending or speaking at conferences. Not everyone is active on Twitter, however, and eschewing Twitter (in our honest opinion) should not be a strike against the entrepreneur.
Google. Google searches will bring up all kinds of information about an entrepreneur. Conference appearances, blogs, articles, or scientific papers they have written, and more.
While it may seem creepy to some people to be scouring the web for information on your startup founders, remember that the internet is largely how the startup is going to generate awareness and promote itself. If they are effectively doing that already across social media, that’s a positive signal of their marketing savvy.
Finally, you can pay services to verify employment or education, but these may be an unnecessary expense if you can find what you need through basic web searches.
Diligence on Market Size
In Evaluating Opportunities we discussed why you want to make sure the startup in question is targeting a large market. In performing due diligence, you may want to do a quick check on that market size calculation.
Let’s start by defining what we mean by market size. A common mistake entrepreneurs make is to use the value of the target industry they are selling into, rather than the value of the product or service they are selling. Using a fictitious example:
exampleA startup wants to sell an IoT tire pressure sensor that costs $10 and is compatible with 19” wheels. The total addressable market is not the value of cars sold, or even the value of wheels sold: it is the value of sensors sold.
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