Entrepreneurs are eternal optimists.
It is not unusual for an entrepreneur to make a presentation to
an investor, get a positive signal of the investor's interest, and
conclude the money is in the bank. In the entrepreneur's mind,
everything else is simply detail. In the investor's mind, everything
else depends on the details. Arriving at these details is a process
known as conducting due diligence.
Investors are picky by nature. They might receive several hundred
business plans per year of which one in 10 might exhibit criteria
that warrant follow-on discussion with the entrepreneur. An
investment may be made in one out of 100 plans submitted.
The fact that a venture capitalist or angel investor does not
fund 99 percent of the opportunities they see does not necessarily
mean those ventures are not commercially viable; rather they simply
may not represent an opportunity that will dominate its competition
with unfair competitive advantages. Investors look for venture
investments that are as close to a monopoly as possible.
Even as picky as they are in selecting investments, investors are
even pickier in researching investments.
Although the business might meet the investor's initial criteria,
offer prospects for a high return on investment, and have a stellar
management team. Investors are generally dispassionate about the
opportunity until a term sheet is agreed to and the background
research is completed.
The term sheet defines the agreed-upon valuation of the business,
financial and legal terms of the deal, rights of both parties and
their legal obligations. Once the term sheet is agreed to, the
research or due diligence process begins.
For the most part, investors initially assess the representations
made in the entrepreneur's business plan based upon their own
experience and knowledge. However, they know that regardless of the
number of plans seen, the number of articles read, or the number of
investments made, they will not arrive at a final investment
decision until the due diligence is complete.
Due diligence is a costly, tedious, time-consuming and necessary
activity to validate the technical, market, and business assumptions
represented in the business plan and to discover answers to
questions raised by information omitted or typically not addressed
in the business plan.
The research approach is to discover the "deal breakers" or major
problems as soon as possible. Taking this negative approach is not a
reflection of investor attitude but is a function of time, money and
efficiency. Since more deals fail to survive the due diligence
process than ones that do, it is only natural to get to "no" as soon
as possible. …