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Flower Shop Due Diligence
3 takeaways from my conversation with Certified Fraud Investigator & CPA John Samore III
Sometimes the work does not happen behind the desk - you’ve got to get out there and see for yourself.
Today, I’m breaking down 3 takeaways from my discussion with Certified Fraud Investigator and former Special Agent John Samore III.
Check out our full conversation + how to connect with John here.
The Observer Express
Don’t have time to read the entire post right now? No worries, here are the main points:
Quality of Earnings = How Accurate are the Financials. A company’s quality of earnings (QoE) is important even if (and perhaps especially if) they’re not profitable. It’s all about how well they’re managing what they DO have.
Understanding the Co-investor Situation and Use of Funds is Critical. “Who else has invested?” and “What are you going to do with the money?” are essential questions to ask.
Consider your Own Risk Tolerance. This helps determine the right time to bring in a pro.
1. Quality of Earnings = How Accurate are the Financials?
So, what is “quality of earnings”?
In the simplest terms, quality of earnings is… ‘How accurate are the financials and what's being presented to you, the angel investor, by the entrepreneur.’
Why is it important?
If an entrepreneur says, Hey, I have a hundred million dollars in sales. Well, that's great, but what's the quality of that hundred million dollars in sales? Is it made up of one customer? Are those customers related party transactions? How much of those sales are collectible? How is it booked? Is it recurring revenue? What type of revenue is it? Is it subscription based? Is it one time? Is it collectible?
Ok, but many angel-stage deals are pre-revenue or have very little revenue. There’s not really much in the way of “earnings” to work with, right?
That's one of the misnomers - the term “quality of earnings”. It's the quality of the overall financials. So in your example, they may have no earnings at this time, but they have a viable, tangible product. So then what you want to look at is where are they spending the limited dollars that they do have?
2. Two Key Questions: Other Investors + Use of Funds
What are some of the most important questions to ask before writing a check?
Here’s what John has to say:
Are there any other investors? Understanding what the cap table looks like prevents surprises down the road.
How will you use the money? John recommends looking for very specific answers. Not simply “30% here, 40% there,” but an actual plan for how the dollars will be spent and what business value that will generate.
3. Risk Tolerance Determines When It’s Time to Ping a Pro
At what point does it make sense to engage a 3rd party for support?
What is your risk tolerance? Are you willing to lose it? Or would you rather take one step further on one particular area that you just want a little more comfort in and, and then make the decision?
Investing a “little”? Don’t worry about bringing in the big guns. Investing a “lot”? Consider pinging your lawyer, accountant, or other diligence pro for help.
Final Thoughts
I’ll never forget John’s experience of uncovering a fraud by physically visiting a flower shop in the Valley. I’ve seen my fair share of poorly constructed P&Ls, cap tables, and financial forecasts, and my conversation with John reinforced the importance of validating those pretty pitch deck numbers before cutting a check.
What Do You Think?
Do you have any stories like John’s?
*I include this section in every post because I’m genuinely curious to hear what you think. I answer every response, so please, don’t be shy!
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3 Lessons Learned
I have dramatically underleveraged the Substack ecosystem.📈I spoke with a friend who built their substack from 0 to almost 1,000 subscribers in about 3 months. Pretty impressive. Apparently a key to that growth was really leaning into the Substack ecosystem. So I spent the weekend learning everything there is to learn about the platform. I’ll be posting notes, comments, and a whole lot more more in the coming days.
Angel investing is a mystery to many entrepreneurs.❓This week I had the pleasure of speaking on a panel discussion with a group of 12 entrepreneurs at the Rice Alliance Clean Energy Accelerator in Houston. The panel was focused on helping these founders understand how to successfully engage with Angel Investors. Many of the questions were quite simple, such as “What’s the difference between an Angel and a VC?” It was a good reminder that angel investors are an enigma to many founders.
Roofers are hardcore.🏠We got a new roof this week. The install crew got the job done in less than a day, and it looks great. Gotta say, was impressed by the work ethic and grit it takes to work through 100+ degree heat and get the job done so quickly.
3 Interesting Links
Tune in next week for a breakdown of my conversation with an investment manager for a premier sports tech accelerator.
Until then, thanks for reading - have a great week.
-Andrew
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How did I do this week?
About Me
I cultivate flourishing.
I'm also the CEO of PitchFact, where our mission is to cultivate flourishing specifically through efficient and collaborative early-stage diligence. I'm a proud husband, grateful father, and honest friend. My love languages include brisket, bourbon, and espresso.