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The 1st lesson we learned after writing 20 seed-stage diligence reports in a month
We’ve been busy.
Over the last few weeks, our team prepared 20 diligence reports, each one analyzing a different early-stage startup. That’s the tightest report density we’ve ever delivered.
In the coming weeks, I’ll share several other takeaways from the project. I’ll also share some information on the deals themselves, so stay tuned!
For now, here’s the first lesson we learned from the experience.
The Observer Express
Don’t have time to read the entire post right now? No worries, here are the main points:
Entrepreneurs are creative. They will always find a way to fill out your application incorrectly. Make it simple and discrete.
The difference between a bad question and a good set of questions on an application for funding comes down to the level of specificity/clarity and simplicity of that question. An entrepreneur should understand exactly what you want to know.
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Lesson 1: Entrepreneurs will fill out your application incorrectly. Make it simple and discrete.
Last summer, I analyzed the funding applications of a dozen Texas angel networks (see more in this post).
Collectively, I discovered 402 unique questions entrepreneurs were asked to fill out. At first glance, that feels completely insane. The natural solution would be to consolidate some of these questions into a “standard application,” and I believe there is a real opportunity there.
But our experience over the last month revealed a new insight that casts this data point in an interesting new light: entrepreneurs often fill out applications wrong. It is therefore effective to ask a higher volume of simple, direct questions that guide an entrepreneur than it is to ask a lower volume of nuanced, open-ended questions.
We made this mistake in a few questions and paid for it by spending a lot of time tracking down answers.
Let me give you an example.
Bad
What are the details of your raise?
Typical answer: $1M SAFE
Technically, this hypothetical entrepreneur answered the question being asked. They shared the basic details of the raise - it’s a $1 million SAFE round. Here’s the problem – as a diligence team member, I have a half dozen follow-up questions that I now must find an answer to. What are the terms of the note? Is there a valuation cap? If so, what is that cap? Is it post-money or pre-money? Is there a discount? What is the discount? Are there any other special provisions to mention?
To answer these questions, additional resources must be spent and diligence report progress is stalled out. But those resources could have been spent elsewhere and the process could have been more efficient if a better set of questions was asked upfront.
Good
Instead of “What are the details of your raise,” it is better to ask several more focused questions with simple conditional logic built-in, such as:
How much are you raising for this round?
What vehicle are you raising through? (SAFE, Convertible Debt Note, Priced Round, Other)
If SAFE:
What is the valuation cap?
Is the valuation cap pre-money or post-money?
What is the discount?
If CDN:
What is the valuation cap?
What is the discount?
What is the interest rate?
What is the term?
If Priced Round:
What is the pre-money valuation?
If Other:
Please explain.
Do you have a signed term sheet?
Please describe any additional terms or raise details not already discussed.
In this case, our dear entrepreneur can’t get away with simply stating “$1M SAFE.” Instead, we learn from the application that they’re raising $1M via SAFE note with a $5M post-money valuation cap and no discount, but that they do not yet have a signed term sheet so things are still negotiable.
Clearly, this information set is far richer, and it was made available to us because of the focused, discrete, format in which questions were asked.
Final Thoughts
This whole issue matters a lot less when resources aren’t constrained and an assessment team doesn’t mind following up. But when we were operating under a tight deadline, we realized how important the clarity and simplicity with which questions are asked makes a huge difference. Next time we run this event, we’ll be making a few changes to the application process.
What do you think?
What are common questions that your investor group is forced to follow up on? How might those be adjusted to improve clarity?
Weekly Observations: 3 Lessons Learned
This week our team had a fantastic time attending the Angel Capital Association’s Annual Summit in Columbus, Ohio. It was like a firehose of customer discovery jam-packed into 2 days. Here are 3 of my top takeaways:
Member engagement is tough for everyone. 💬Apparently, the typical angel group sees anywhere from 20-30% member churn every year. Anything below 15% is fantastic. Lots of strategies for improving member engagement, but defining what type of engagement is important to your group is the first step to improving it.
30-40% of Angel Networks operate with some kind of fund attached. 🔗This was surprising to me. It’s growing more and more common for angel groups to offer and/or require participation in some form of an associated fund. I was impressed by the variety of fund structures at play, and this is something I am curious to explore in the coming months.
We need more case studies.📖Angel groups generally understand how “diligence as a service” could benefit them. But why should they trust us, some company they don’t know, with something as important as due diligence? It’s a fair question, and I was encouraged to build out a few solid case studies highlighting the value we’ve delivered. We’ll bring some next year!
Bonus: Andes mints are God’s candy. 🍫We went through 2 boxes in 2 days, and everyone snagged some. Next time we’ll get smart and tape the mints to our flyers!
Weekly Links: 3 Things I Found Interesting
Thanks for reading, have a great week.
-Andrew
If you enjoyed this post, please share it with a friend, colleague, or anyone else who may benefit.
P.S. - I recently finished creating The Angel Network Toolkit: 90 Resources for Cultivating a Thriving Community of Pre-Series B Investors, and I’m sharing it with anyone who refers a friend.
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.