VC Cliche of the Week

Due Diligence.

I’ve used those words so often I can’t even count. 

I’ve used them a bunch of times on this blog.

Due Diligence is the name of the excellent blog by venture capitalist, Tim Oren.

But what do these two words mean?

I think they come from contract law where one party was required (due) to avoid harming another (by being diligent).

I am sure there are lawyers out there who can provide a better and more accurate history of the term.

In the venture business, it means the process by which the VC learns all he or she needs to know about a potential investment.

But in practice the due diligence process varies so much from firm to firm and deal to deal that it is more art than science.

Every VC firm has a "diligence checklist" that lays out all the things they need to know before they can close on a deal.  But very few firms do diligence by checklist.  For the most part, diligence is about making phone calls and taking meetings with people who know the company, the people, the market, the technology, and yes all you entrepreneurs paranoid about collusion – competition.

In the public markets investors often do a fair amount of work on a potential investment before pulling the trigger and buying stock.  But if they are wrong about the market, the people, the technology, or if a new competitor pops up, they can always sell their stock and take a loss (or possibly a gain) and move on.

It doesn’t work that way in the venture capital business. Once you jump off the cliff, you can’t get back on it. 

I often make the comparison between due diligence and dating.  The analogy goes further as the signed term sheet phase is the engagement and the closing is the marriage.  Hopefully all goes well and the marriage doesn’t end in divorce.

I am not joking about this.  A VC investment is not marriage, but it’s damn close.  One thing I’ve noticed over the years is that the VC does a lot of due diligence on the entrepreneur and his company, but entrepreneurs often do not do enough due diligence on the VC and his firm.

You can never do enough due diligence.  You can and should call and visit every competitor and their VCs.  You can and should talk to everyone you possibly can about the entrepreneur and the senior management team.  You can and should get into the market and talk to customer and/or potential customers.

And once you close the investment and get married, you should continue your diligence and never stop until the investment is exited.

Due Diligence and venture capital go hand in hand.  In many ways they are two side of the same coin.