Step into any venture capital office, and there’s a pretty good chance you’ll hear the term “DD” being thrown around. “DD”, or “due diligence”, is the intense research VCs will undertake before investing.
As we found out from Doug Oliver, Head of Platform at TEN13, over 300 hours of DD will go into each deal.
Let’s pause for a bit. When was the last time we took such an analytical lens to our career opportunities? 🧐
VCs choosing where to invest their capital is not too different from you or me choosing which company we’ll invest our time in.
When it comes to startups, this is even more important as they are typically a riskier investment option. High risk, of course, comes with a high reward, so how do we put on our VC hat and do our own DD on potential startup roles? We chatted with Earlywork Community member and Investment Analyst at Folklore Ventures, Abhishek Maran.
Take it away, Abhi!
Not all startups are made the same.
When joining a startup, it's important to do some due diligence prior to joining. A lot of the time, we're happy that we've got a job offer, and don't think twice before accepting. However, in the world of startups, thinking twice is crucial given the uncertainty and varied experiences that you could encounter. The three main areas where you should do further digging and thinking are: people, product and funding.
At any startup, the quality of the founders and employees are incredibly crucial in determining if the startup can successfully execute on its vision. Trusting and believing in the founders to execute is sometimes more important than believing in the brand/product.
Typically, the best startup founders are the ones that have run a successful business before. They know where the challenges lie in executing their vision and can expertly navigate past tough problems. Successful entrepreneurs also most likely know other talented people and can build out a strong team through their network.
Alternatively, working for first-time founders is not a bad thing, but there are a few things you should look for when assessing their skills.
- Generalists. Typically management consultants, investment bankers and lawyers are proficient in their problem solving, placing them in a strong position to be good founders
- Specialists. Domain knowledge experts who have worked for a long time (5+ years) in their chosen industry
- Network. This is partly a by-product of their work history, but the early stages of startup success can be facilitated by leveraging existing networks. It's worth doing short 15-minute reference calls about the founders to find out more about them.
- Team composition. Most startups will usually have two or more co-founders. The ideal combination would be people from different backgrounds with unique skill sets, so you’ll often see one founder who is more business-focused and another who is more technical.
Team Size and Org Structure
Team size and structure really depend on the amount of funding the startup has received, the stage of a startup, the relative strengths and weaknesses team members possess and the level of sophistication of the product that the startup is building. You’ll find that team sizes vary greatly. In some cases, you might be the first employee outside the founding team, or alternatively, you might be a part of a 10-person engineering team.
Delving deeper into team composition, it's important that both business and engineering teams are built out thoughtfully and strategically.
Depending on the nature of the product, the size of business/operations teams can vary wildly. However, in most cases, teams will likely be lean, and employees might have multiple focus areas
Engineering teams are crucial for tech startups in terms of actually building the product. In most cases, you'll find an assortment of front-end, back-end and full-stack developers in the team.
🚩 People red flags: Inexperienced founding team (<2 years of overall experience), Unbalanced teams (e.g. a disproportionate amount of front end devs vs back-end devs).
Market Size and Competition
The best businesses operate in huge markets with low competition. To get a general sense of the size of a market, a simple Google search is sufficient. From here, you'll need to forecast realistically how much of the market the startup can realistically capture given their business model. For subscription-based revenue models, the potential number of subscribers is key, and for take rate revenue models, basket size and purchase frequency are important. A lot of this will just be light forecasting or a best guess of what the startup could do, just be confident that the startup can capture a significant slice of the total market.
For competition, use Google and Crunchbase to determine who the biggest competitors are. Competition isn't always a bad thing as it can help prove if a market exists for that style of product. However, it's important to understand the strengths and weaknesses of a startup's competitors. Pay attention to the amount of funding competitors have raised, their business model and level of traction. If competitors are well funded with a high level of traction, it will be incredibly tough to compete unless the startup's product has a unique competitive advantage with embedded defensibility.
PMF, PMF and PMF!
Product Market Fit (PMF) is likely a term you've heard thrown around, but what does it actually mean, and why should you care about it? PMF essentially asks, does the product actually solve a pain point for a set of customers, and have those customers adopted this product?
With an early-stage startup - PMF is where a lot of the risk lies. It can often be hard to tell if a startup has achieved PMF, but there can be early signs:
- Strong social media engagement and reviews. Having good engagement on socials likely means that customers like the product and identify with its mission.
- The product actually solves the problem users face. Ideally, you are in the key demographic of users for the product. This way you can actually tell if the product actively solves a problem that you face. If you aren't the target demographic, then ask someone who is, to review the product and give you their thoughts on it.
- High growth rate. A high growth rate usually means that people are intrigued by the product and are curious. Hopefully, the product is sticky enough that there is a high retention of users. You should ask about this during the interviewing stage.
- Differentiated and defensible product. A differentiated product is key to achieving PMF as it provides a different value proposition to customers. Without a differentiated product, there isn't likely a good enough reason that would compel customers to switch to your startup's product.
🚩 Product red flags: Numerous competitors with similar products, small market size.
As with any job, getting paid is important, so make sure the startup you are joining has enough money to pay you. For early-stage startups, this might be harder to determine as some might have raised money from angels or family and friends. There's nothing wrong with joining a startup at this stage, just keep in mind that you'll be taking greater financial risk.
Startups funded by top tier VCs who have a history of picking big winners are usually a bit safer. Startups in this category will have strong people in and around the business guiding the startup to success. Additionally, you can be more confident that they have enough money to pay you and can likely raise more money from VCs in later funding rounds.
Regardless of the type of funding a startup has received, make sure to ask about the startup's financial runway whilst interviewing. The longer the runway, the more financially stable the company.
🚩 Funding red flags: Unless it's a really early-stage startup, not receiving substantial funding (~500k or higher), being asked to work for free for a period of time.
Overall, joining a startup is a risky – but ultimately rewarding – move for anyone, but there are a few things you can do prior to joining to ensure that the move is the right one.