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Telling the stories of startup founders and creators and their unique journey. Each episode features actionable tips, practical advice and inspirational insight.
00:00:00:00 - 00:00:09:23
Welcome to the Founders Journey podcast. Inspiration education for Founders by Founders.
00:00:09:23 - 00:00:29:11
Hey, I'm Greg Moran from Evergreen Mountain Equity Partners in the Founders Collective. Today, I want to dive into a critical part of angel investing, and that's around due diligence. Identifying red flags during the due diligence process can make all the difference between really successful investment and a costly mistake. Before I start, let me just start out with the statement of the obvious.
00:00:29:16 - 00:00:52:17
You need to be doing due diligence. And I say that because I often see angel investors. You need a founder. Write a check. There's not much there. They really don't understand what they're investing in. So what we're going to talk about today is how to actually do due diligence. We're going to guide you through the red flags to watch out for, particularly those related to founder selection, business model, viability and market fit.
00:00:52:19 - 00:01:17:06
By the end, you're going to have a toolkit for really evaluating startups more effectively to make you a better investor in startup, asset class startup investing is really high risk. Over 75% of venture backed startups never deliver a positive return. Sounds terrible, but the other 25% often deliver outsized returns. And that's where the money's made, right? So through thorough due diligence.
00:01:17:08 - 00:01:35:17
This is really what it does, is it allows you to get a better understanding of the startup's potential, the risk factors, and whether it's worth your investment and your time. Because startup investing is not only, you know, it's not just writing a check. The best investors are going to get involved in the company, at least from a guidance perspective and contacts and things like that.
00:01:35:18 - 00:01:57:07
So you really want to understand whether it's worth your investment, it's worth your time and your contacts and and your experience. However, many red flags don't immediately stand out. There are often really subtle indicators within financials within the founder's character and the products market fit. So today I want to cover five key areas of due diligence where you should look for potential red flags.
00:01:57:08 - 00:02:19:05
Evaluating the founder is arguably the most important part of due diligence. Even the best business model is not going to succeed if the founder lacks the skills or the character to lead, that founder needs to take this business from a very early stage, often through a scaling stage, which can be quite difficult to do. You really have to make sure you've got the right founder at Evergreen Mountain Equity Partners.
00:02:19:05 - 00:02:42:19
That's our that's my venture fund. We developed a proprietary founder assessment to ensure that we're backing founders with the right traits. So it's what we use when we're doing founder diligence. We specifically look for what we call the entrepreneurial adaptive innovator model. So it's an archetype model that we built based on our own research, looking for founders who are resilient or humble.
00:02:42:19 - 00:03:09:03
They balance risk taking and they're accountable. That's really what we're looking for. I mean, so around resilience, the ability to navigate setbacks and maintain momentum even in the face of challenges. Humble assertiveness is really around the confidence combined with openness to feedback. It requires confidence in one's ability to accept feedback and accept coaching. And that's really what we're looking for with humble assertiveness, with strategic accountability.
00:03:09:09 - 00:03:37:13
What we're looking for is ownership of decisions and a willingness to pivot when it's needed, that they're not going to get stuck on a path because they need to prove themselves right. So during due diligence, red flags like unwillingness to accept feedback, a pattern of overpromising or lack of strategic accountability can really indicate future issues. So founders who lack resilience, for example, often struggle to handle the inevitable challenges of scaling a business before we move on to the next one.
00:03:37:13 - 00:03:55:02
If you want more information on the assessment model that we're using, Joffrey, just go to MVP. IO. You can download the white paper on the Entrepreneurial Adaptive Innovator model on assessment. We're happy to provide the tier free of charge. If you're evaluating an investment today and want to put the founder through it, have to do that. MVP, IO product market fit.
00:03:55:02 - 00:04:20:20
Now moving on to the next one here. Product market fit is critical for any startup success, right? A startup without evidence of clear product market fit often struggles to really gain traction, and they often struggle to really retain customers if they do happen to get them during due diligence. You need to be looking for metrics that prove market demand things like customer retention, engagement rate growth, and paying customers.
00:04:21:02 - 00:04:38:05
We just released another video on metrics to be looking for in startup investing. So I encourage you to listen to that one on our channel as well. To give you an example, if a SaaS startup has a high churn rate and it's losing more customers than it's gaining, it's likely a sign that they haven't achieved product market fit.
00:04:38:05 - 00:05:02:11
They might be getting early adopters to buy, but they're unable to hold them because the product isn't where it needs to be. Another indicators if most customers are using only one part of the product with that often does suggest that the full solution is resonating. So customers are latching on to one thing, but not the full product. That's not an insurmountable problem, by the way, but you do need to understand that so you can help guide and inform the strategy of the company.
00:05:02:13 - 00:05:23:03
You know, one of the big red flags, flag indicators here around product market fit, high churn rates indicate poor product market fit, customer complaints, or lack of repeat customers that signals product mismatch without solid proof of product market fit, a startup's growth potential is limited and it becomes a riskier investment. You want to be understanding product market fit.
00:05:23:03 - 00:05:42:18
The next area that we're going to dive into is financial projections. Now, this was an easy one to throw out when you're dealing with startups. Everybody says, well, yeah, but nobody ever hits their projections. That's largely right. But what you're looking for is some insight into the way that founders thinks and into the startup's growth potential, but they're only valuable if they're actually realistic.
00:05:42:20 - 00:06:07:23
So watch out for overly optimistic financial forecasts without a solid basis, right? Really push with the founder on the assumptions that underlie it. That's way more important than the actual numbers, the underlying assumptions, because with false assumptions, a lack of a real foundation to the model can really indicate either complete inexperience on the part of the founder, or real overconfidence on the part of the founder.
00:06:08:03 - 00:06:29:14
And they may be in for a rude awakening. So if a startup is predicting 200% revenue growth annually, but there are already clear milestones, there's not realistic assumptions. May be a red flag, a sustainable growth trajectory, even if it's more conservative in the early stages, often indicates better long term planning. It probably indicates a founder who's thinking critically about their business.
00:06:29:16 - 00:06:53:11
So one of the red flags to look for inconsistent financials. So discrepancies between revenue cost margins the numbers don't add up right. See this all the time in early stage startups you might find a mistake or two. But there needs to be. They really need to have put the work in to develop a strong model. So during diligence, challenge the assumptions behind the financial projections.
00:06:53:13 - 00:07:14:23
If the startup can't explain the numbers clearly or why they created those numbers, what those underlying assumptions, it's a sign of poor financial planning or a lack of understanding. Either one can be a problem. So another critical metric to evaluate is the ratio of customer acquisition cost to lifetime value. We talk about this in our video on metrics.
00:07:15:04 - 00:07:45:10
Startup metrics really encourage you to listen to that. A startup with a high what's called customer acquisition cost, but a low LTV lifetime values. What that stands for is essentially spending more money to acquire customers than it can recover through revenue. So ideally, LTV should be at least three times Cacc, which indicates sustainable, efficient growth. They're making three times more money on the investment that they're putting out there to get that customer in the first place.
00:07:45:15 - 00:08:11:06
So let's say a startup has a stack of $100 per customer, but it's only generating $150 in LTV. This is a big warning sign, as though barely breaking even, and they're unlikely to scale to profitability. So in that example of a startup with a stack of 100, you really want to be seeing if there's any time that the company's been around for any time at all, you really want to be seeing a strong trajectory toward, you know, a 300% long term value in order to determine this.
00:08:11:06 - 00:08:27:07
Now, one obvious question that comes up all the time. What if the company hasn't been around that long? How do you know how long they're going to hold on to churn rate is the answer to that. So if a company is getting 10% churn years, it has 90% gross retention. You can make an assumption that that company will be around for nine years, right?
00:08:27:07 - 00:08:46:23
They're churning 10% of their customers on an annual basis. So 90% will stick around. So you can start to make some assumptions like that to get a gauge. So if you see high churn rates in a high catch run. So the big red flag indicators, high cap with low LTV that's unsustainable cost growth super inefficient and poor LTV to cap ratio.
00:08:47:01 - 00:09:03:05
It really should be in the 3 to 1 areas really what you're looking for. So without a balance delta v to cake ratio startups are going to struggle to grow and they're going to burn a lot of cash on customer acquisition. That's going to cost you as investor a lot of money, or the company is going to run out of money really quickly.
00:09:03:07 - 00:09:27:07
So finally, you need to consider the startup's target market and their competition. When you're doing diligence, a small market size limit to startups growth potential. But an overly crowded market makes it harder for new entrants to gain traction, or especially a market that's dominated by some really big players. So doing diligence, you really need to evaluate the startup's market share potential over the long run.
00:09:27:09 - 00:09:51:02
And what's their competitive differentiation they need to be able to break out of the noise is the hardest thing for startup to be able to do. Differentiation is really the only way that they can really do that without spending gobs of money. So if a startup's product faces intense competition from really established players and they don't have a clear differentiation from those players, it's going to struggle to capture a meaningful market share.
00:09:51:02 - 00:10:18:12
I don't care how good their ideas are, how big the market is. So what are you looking for here for red flags? Small market size? That means limited scalability potential, lack of competitive differentiation. Really no unique value proposition compared to competitors. So you need to understand the competitive landscape and that's really essential for assessing whether the startup has a realistic growth path and can break out of the noise.
00:10:18:12 - 00:10:39:14
So to sum it all up, there's a lot here to due diligence really helps you identify the critical red flags that can make or break an investment. You need to pay close attention to founder qualities, product market fit, financial projections, LTV to catch ratios, and market size and differentiation. A disciplined approach. And that's really what this is all about.
00:10:39:14 - 00:11:01:06
A disciplined approach to diligence is essential for success and startup investing. So dig in if you're going to put the time in, if you're gonna put your money and dig in and put the time in to really understand what you're doing. So if you're interested in learning more about startup diligence or how we evaluate founders at Evergreen Mountain Equity Partners, I hope you go over to MVP radio and reach out to us.
00:11:01:06 - 00:11:28:11
We'd love to chat with you about it. Our proprietary founders assessment and diligence process ensures that we make data driven decisions and, you know, happy to share those things with you. So thanks for watching. Don't forget, please take a moment like subscribe. Hit the bell to turn on notifications. To continue to get our content. Feel free to drop your questions in the comments below and we'll see you next time.