As investors, finding a company we want to invest in is huge.

This process often involves looking at 1000s of pitch decks and taking 100s of meetings. So when you finally find a team you want to back… that’s huge.

It’s normal to get excited.

But there’s one crucial step that you need to take before wiring the money: due diligence.

Due diligence is the process of investigating and evaluating a potential investment.

But not all investments require the same level of due diligence.

For some investments, due diligence can be limited to lightweight investigations. Others will require an exhaustive analysis of financial projections, team backgrounds, legal documents, and market research.

The scope of your investigation will depend on two things:

1. the size of your potential investment
2. the stage of the startup

Let’s dig in.

Check size and due diligence should correspond  

Startups are inherently risky, and due diligence is your best defense against making ill-informed investments.

But the amount of due diligence you perform should be proportional to the size of your investment.

For large investments – like $1m – you’ll want to conduct a thorough investigation before writing a check.

But for smaller investments – like $1k or $5k – due diligence doesn’t need to be as exhaustive.

Due Diligence for Small Checks

You're not expected to spend weeks poring over documents for a $5,000 investment. Here’s what lightweight due diligence could look like (along with further optional reading):

1. Reviewing the pitch deck: I mean… obviously.
2. Meeting the founders: Ask questions about the team’s domain expertise, customer discovery, and traction.
3. Product discovery: If possible, try the product yourself.
4. Market research: Here’s an example of how to approach this.

Remember: your goal is to be informed about the company and confident in your decision without wasting excessive time or resources on an overly in-depth investigation.

Due Diligence for Large Checks

As your investment size grows, so should the depth of your due diligence.

For checks of $1 million or more, you'll want to conduct a comprehensive investigation. Here's what you should focus on:

1. Financial projections and actual revenue: Companies at the Series A stage or later should have some financial traction. Analyze their projections and compare them to actual performance.
2. Customer contracts and quality of revenue: Look beyond the numbers. Are these high-quality, recurring customers, or one-off deals?
3. Cap table analysis: Ensure the capital structure makes sense. You don't want to invest in a company where previous rounds have left little room for new investors to see returns.
4. Documentation review: Later-stage startups should have organized documentation in tidy data room.
5. Investor reference checks: Talk to previous investors about their experience with the founders. Your goal is to understand what it was like to work with these founders. Are they coachable? Do they learn quickly? How has the journey been?

These conversations can provide invaluable insights into how the startup operates under pressure and how the founders handle challenges.

Stage plays a role

The startup's stage also plays a crucial role in your due diligence.

For early-stage companies, there might not be much to analyze beyond the founding team and their idea.

They might not have customers, revenue, projections, or even a data room.

For pre-seed investments, your goal is to get a sense of the opportunity and the team behind it.

As companies start to get into later stages, like Series A and beyond, there is a lot more information to dig into. That’s when it makes more sense to thoroughly investigate customer contracts, financial projections, cap table organization, and that oh-so-exciting data room.

💡One thing to note: if you are new to angel investing, we strongly recommend starting with small checks, even if you can afford larger ones.

Writing small checks gives you more shots on goal – more opportunities to learn what makes a great team, what challenges are inherent in each industry, what makes a product sticky, and what customer acquisition looks like.

This experience is going to be a critical part of your investor education.

Some qualifications to consider

Due diligence is important. But it won’t safeguard against everything.

One example of this is background checks on founders.

Background checks can uncover red flags, but they're not definitive. It’s certainly possible to invest in a founder who later commits fraud, or for a founder with a history of fraud to evade background check systems.

This doesn't mean you shouldn't do background checks. Just be aware of their limitations.

Similarly, reference checks from previous employers might not tell you much about a person's ability to run a startup.

The skills needed to excel in a corporate job are often very different from those required to build a company from scratch.

It’s all part of the process

Due diligence is not just about protecting your investment; it's a learning process that will make you a better investor over time.

Each startup you evaluate will teach you something new about what to look for and what questions to ask.

And that education is priceless.

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