Why Startups Must ‘NOT’ Dread The Idea Of Due Diligence By Investors

Most entrepreneurs dread the idea of subjecting themselves to due diligence by investors. They pride themselves on their autonomy and domain expertise and don’t find the concept of someone digging into what they’re doing very appealing.

Some feel threatened when an outsider who has very little operational skills or real-life experience dares to ask them questions, and challenge what they’ve done so far – and dispute their projections. And they resent having to be answerable to investors just because they have deep pockets.

However, in the startup ecosystem, as in other parts of life, the Golden Rule applies – the person who has the gold makes the rules! 

Entrepreneurs need to reframe their perspective and understand that the due diligence process can actually add a lot of value to them. Yes, it’s true that you’re likely to feel uncomfortable because you’re forced to expose all your weaknesses, but you can learn a lot from an independent, intelligent outsider’s perspective.

Rather than think of it as a confrontational or adversarial exercise, remember that financial-savvy, experienced investors can provide you with valuable insights, which can help you fill in the gaps which would otherwise you to fail as time goes by.

A good investor will show you a brutally honest mirror. He will administer tough love, and pick holes in your business plan – and not because he’s wicked or wants to pull you down. He has no interest in demonstrating his superiority – don’t forget, he wants you to succeed, and this is why he is looking to invest in you! He’s going to give you his hard earned money, and he wants to be sure that your business is waterproof and watertight.

Even though he knows that the odds of your failing are high, he is still willing to invest in you – please treat this is a marker for the degree of confidence he has in you!

He needs to make sure that you’ve thought about the potential weaknesses in your business model, and that you are mature enough to acknowledge these. He needs to find out if you are coachable, and are willing to fix the gaps which will definitely crop up as you make progress. Often founders find themselves stuck in the trenches having to tackle the daily problems which confront a startup, and they may end up losing their perspective.

A well-structured due diligence exercise can help you whip your accounting and governance in shape. Now, these are not the things which most entrepreneurs worry about routinely because there are too many other daily fires which they need to put out. However, unless you address these, you’re never going to be able to grow your company successfully.

A well-informed investor can educate you about your competition, and you can learn how they view the other players in your domain. He can give you helpful insights because he has a 30,000 view. Now you may feel that it’s not fair that investors who don’t need to get their hands dirty should be preaching to you from their comfortable ivory tower seats, but you need to learn to take the entire due diligence exercise in the right spirit.

Yes, the investor may not have as much expertise in your field as you do, but don’t forget that he has helped other startups to grow, and this experience can be invaluable in preventing you from imploding! He can also help you to polish and improve your business model, and help you explore new markets you may not have thought of.

Think of the investor as being a consultant from McKinsey, who is going to look into the bowels of your startup, so he can help you fix problems at an early stage, and help you make your foundation much stronger, so you don’t have to deal with organisational and cultural debt later on. And the best thing is you’re getting this opinion for free, so make the most of it!

---

[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]