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Posts Tagged ‘due diligence’

breakingthroughAs we’ve outlined on this blog over the last few weeks, the system for raising early stage capital today is fundamentally flawed. Even though the road to success for entrepreneurs trying to kickstart their visions is littered with potholes and deceptive directions, it can all be corrected with a little teamwork. If change is going to happen, we can’t just tease the entrepreneurial community with brief moments of candor and transparency. The only way we truly accelerate the rate at which that innovation is created in this country and solve our financial crisis is for us to come together and provide enormous value back to the very entrepreneurs from which we expect that innovation to come. By the way, that busted road we mentioned…it’s a two-way street.

So without further ado, here, in no particular order, are North’s 10 Rules for Breaking Through:

1. Listen To The Challengers, Not Just The Congratulators.

listentoyourcriticsTurning an idea into an actual operating company is hard work. So make it easier on yourself, bounce your concept off those people that have no problem ripping it apart. Seriously, if all you do is play “show and tell” with your trusted inner circle are you really going to learn anything new? Feedback from candid and objective outsider can often make the difference between your business growing and maturing vs. remaining underdeveloped. Are you listening?

2. Don’t Buy Anything That Doesn’t Provide Value Back.

As mentioned throughout this paper, there are a ton of services marketing at entrepreneurs, especially those that pitch the promise of raising money or connecting you with investors. However, before you take the plunge (or get out your credit card) ask yourself a simple question, “am I getting useful value back?” What you’re doing is hard and takes a lot of time, don’t waste it. Surround yourself with experts that can inspire and help you reach your goals.

3. Those With Fewer Words Win.

We can’t express enough the importance of being able to concisely state your business idea in a very persuasive manner. Investor’s have limited time and even a more limited attention span (do you know how many pitches they hear a day?). If your “single sentence” about what you do and how you make money is confusing, you’ve wasted your breath and other’s time. Take time to dial this in. The results will follow.

4. Talk To Anyone Who’ll Listen.

Okay, quit hiding behind your laptop screen and go talk to people. If you’re too remote and working from a tropical island somewhere (good for you), but at least pick up the phone. Investors know each other and if you talk to large number of them it can actually create more buzz about you and your concept. Healthy competition is good when it comes to raising money. The more options (and contacts) you have, the better off you’re going to be. Lastly, when you’re doing all that talking, be sure you don’t forget to take pauses and listen! (see #1).

5. Momentum Is Your Friend, If…

Don’t waste precious time hunting for cash if you’re not yet “investor ready.” Keep dialing in your business model and make that sucker bulletproof. As an entrepreneur, it’s important to stay focused, inspired, and moving forward with steady pace. If you know which direction you’re going, it’s okay to sprint. On the other hand, if you have no clue where you’re headed, slowdown hombre. Speed without direction is the fastest way to getting nowhere.

6. Start Smart Or End Stupid.

Take it from people who have “been there done that.” Be wise with your time in the early stages. If you’re not truly confident and frequently find yourself second-guessing your path, stop. “Green” entrepreneurs blast out their concept stage plans when they’re not even mature enough to be considered for funding (and then wonder why they hear crickets?). Instead of taking this route, go meet with experts that can help you tighten up your concept, train of thought, and give you an indication whether you even have a viable idea in the first place. You’ll be smarter for it, and a more prepared entrepreneur the second time around.

7. Heighten Your Bullshit Radar.

The early stage investment capital space is crawling with unsavory characters. Do all you can to avoid a lengthy unfruitful and expensive ride on the scam tram. We already mentioned in #2 above that you should seek out value. Well, in order to do so, you must first sharpen your perceptive skills. If someone says they “know how to find you capital” (and they haven’t shown you and credible evidence that they know how), ask them how they intend to do that. Remember during the last presidential race when John McCain proclaimed, “I know how to catch Bin Laden.” Hey, if he knows how to “do it” then why hasn’t he shared it with anyone already. It’s because it’s just desperate drivel from a man seeking votes from unperceptive swing voters.

8. Cash Is King.

Do your economic models scale beautifully? Do you have a solid way to make money? Can you prove it? If this part of your plan is not credible, you will quickly be voted off Start-up Island. No question about it. If an investor were hosting the show Survivor, they’d say, “Bring your business plan up here (after handing it to them, they toss it in the fire). The tribe has spoken. It’s time for you to go. The rest of you looking for funding, head back to camp and work on your financial models.”

9. Don’t Wait In Line.

beheardQuit trying to shout “me…me…me” in the crowded pitch farms. This is a complete waste of time, effort, and money. In order to break through with investors, you’ll have to take risks and do whatever it takes to get noticed. Don’t just show up on the congested scene with one arrow in your quiver. Arm yourself with third party due diligence, a working prototype, or some other vehicle that demonstrates that your business is worthy of attention and funding consideration.

10. Sell Something Dammit.

cashregisterIf you are starting a business, sell something. Nothing builds excitement, momentum, and revenue faster than actually ringing a real register. Far too many new ventures focus on research and development and by the time they have a product, the market has moved. They never got real consumer feedback and they wound up running out of money before they were able to hang that first dollar on the wall. If you want to succeed, make sure the “selling” component is a well-oiled machine. It’s the difference maker.

This is the conclusion section from our recent paper, Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

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I ran across this interesting article today from John Hollinger of ESPN.com, where he took his Player Efficiency Rating stat (PER) one step further (PER is Hollinger’s overall rating of a player’s per-minute statistical production).

He came up with a new acronym: VA. It stands for “Value Added.” The idea behind VA is to take the difference b/t a given player’s performance and that of  a “replacement level” talent – perhaps a player that rides the pine and doesn’t see a lot of quality playing time.  So to get VA you multiply that difference by the number of minutes that player played. The result shows how many number of points the player added to his team’s bottom line on the season.

Hollinger says VA is an excellent predictor of this year’s MVP (really a two-man race now b/t Kobe Bryant and Lebron James),  because it allows us to compare players with disparate production and minutes — say, one player who was brilliant in 60 games and another who was merely good but played all 82 — and figure out which performance was more productive.

That’s not all, there’s another acronym Hollinger analyzes, called EWA (Estimated Wins Added). EWA is the same idea as VA, except that the result is expressed in terms of wins instead of points. This is helpful if you’re trying to figure out the impact of, say, removing LeBron from the Cavs or Kobe from the Lakers.

I pointed out in a earlier blog post called Are They Ready For Prime Time? that professional sports organizations have long been using statistical analysis to conduct due diligence on athletes. The athletes that are predicted to have the most upside are the ones that get drafted, make millions of dollars, and go on to have the most successful careers.

In his review of the book Wages of Wins, Malcom Gladwell wrote, “Weighing the relative value of fouls, rebounds, shots taken, turnovers, and the like, they’ve created an algorithm that, they argue, comes closer than any previous statistical measure to capturing the true value of a basketball player. …Looking at the findings that Berri, Schmidt, and Brook present is enough to make one wonder what exactly basketball experts—coaches, managers, sportswriters—know about basketball.”  Well, after reading Hollinger’s article today, I think Gladwell can remove sportswriter from his expert list…

But this VA acronym that Hollinger has coined raises an interesting question. How can we apply VA to the business world? Well, it’s something we debate nearly everyday. Will Apple’s stock turn sour without Steve Jobs running the show? What will happen to News Corp when Peter Chernin steps down in June and is replaced by average talent? Which executive is more valuable to their team? At North, we love this kind of stuff. We’re all number’s geeks at heart.

Oh, I almost forgot. The winner of this year’s NBA Most Valuable Player Award according to Holinger? King James by a landside. As a lifelong Laker fan it pains me to write that, but after looking at his statistical rationale, it’s extremely hard to disagree. Read the full article on predicting the MVP here.

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Entrepreneurs are an interesting bunch. While nearly all of them have an “I can do it myself” attitude, which is crucial to get the ball moving, that same attitude usually ends up preventing the company from scaling. The truth is there are some situations where you simply can’t be the most effective person for the task. Now if you have to lean on others (something you should get comfortable with if you ever want to scale a business where you don’t work 22 hours a day), you should think about the cost/benefit relationship of doing it yourself or having someone else do it for you.

Think about it. Can you be a reference for yourself? How is an investor to trust an entrepreneur who has conducted his or her own due diligence? These are a few examples where you simply CAN’T do it yourself. In fact if you even try, it starts to have an inverse effect. Try telling an investor that you’ve done a background check on yourself and that it came back clean (and please film their response and send it to us if you can…).

Also, when you are looking at which aspects of the capital raising process you need to offload, be realistic about the time factor here. Sending an email to X number of Angel groups or VCs takes about 30 minutes each (to find the site, read about them, then apply), take that number and multiply it by X applications and we’re looking at X hours. At what point does it make sense to pay someone to do this work for you?

240 Investors X 30 minutes = 120 hours. Okay, if you do this yourself that means that you could spend 8 hours a day every working day for three straight weeks, sending (not responding to) emails. Is this a good use of your time?

For investors it’s the same problem. Reading 40 business plans a month for 30 minutes each = 20 hours of reading. Before an investor has even picked up the phone, or a golf club for that matter, they’ve already spent 4 hours a day reading highly subjective business plans.

Most Angel groups perform their own due diligence, which for most groups means handing off the task to a “casual” investor member who then has to take on the responsibility for the entire group and conduct some free form analysis of the venture. Don’t be surprised to hear that most investors arms retract approximately 4 inches into their shoulder sockets when someone is asking for a volunteer to perform due diligence. For the Angels, It’s hard to get enough to do it yourself, not to mention the threat of having to corral your investment buddies in order to perform a thorough analysis of the company, that is, assuming you can get any volunteers to help you at all. For the entrepreneur, due diligence is a distracting, time consuming effort that ultimately takes away from their focus of growing and improving their business. Outsourcing this work may be a way for both parties to get back to doing what it is they want to be doing. A standardized set of criteria for this process would also provide complete transparency, allowing both investors and entrepreneurs to be on the same page when it comes to evaluating the strengths and weaknesses of a business.

Many investors admittedly invest in the management team rather than in the idea, essentially betting on the jockey, not the horse. This makes sense, since the most other parts of a business can be easily changed. But it’s unrealistic to expect even the best management team to bring a genetically flawed plan to market with any kind of success (remember Kwame Brown?). Investors need to be clear on the whole picture; without such insight it becomes betting rather than investing. In fact, a study done by Willamette University’s Rob Wiltbank shows that Angel investing is actually riskier than people think. The study found that 61% of the Angels surveyed had returns greater than the amount they invested, which means that 39% didn’t! That’s not a surprising statistic; investors simply are not taking the necessary steps to provide themselves with all the information available to them.

act_satLooking at the world of college admissions we see a highly standardized method for measuring prospective students in the SAT and ACT tests. These tests show how you can have a straight A student from a small high school who may not score nearly as high as a B student from a top ranked private school. While the standardization of analysis would be powerful, what really matters is if the investors value the standard.


There are no analytics that tell the entrepreneur who is reading their plan, how it has been distributed, and what parts they are spending the most time on (or how much time they are spending reading it in general). This data is simple to capture and may give an entrepreneur some valuable feedback as to whether or not their plan is getting into the hands of people who can help them grow, and how they are receiving it.

Look for opportunities to transform investment review into something that is more attractive. That is to say, as an investor you have the ability to greatly influence the plan and direction of a company. Some simple suggestions or compromises may make the investment much more feasible for you and also help out the team in the long run.

The following excerpt is taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

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The following excerpt is taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.


kickingtiresBuying a used car is an exciting process, but coming home with buyer’s remorse is easy if you don’t do your homework. To avoid a financial disaster, not to mention having a two-ton paperweight parked in your driveway, it’s prudent for any buyer to bring an experienced mechanic with them to look at the car before an offer is made. Why not do it yourself? Unless you’re a gear head with extensive knowledge of the vehicle you’re looking at, you’re better off shelling out the 300 bucks to make sure you’re not going to have to sink thousands into the car as soon as you get it home.

A quality mechanic with experience in checking out used cars will have a systematic inspection process that will cover all the bases in terms of the integrity of the car. Their trained eye will surely find the spots where the previous owner slapped on some Bondo to cover up where they were sideswiped, and can sniff out the sawdust in the engine.

“When excited buyers get emotionally caught up in the vehicle purchase, they often miss mechanical, cosmetic, and safety issues during visual inspections and test drives…to eliminate much of the anxiety and get an accurate picture of the condition of the vehicle, many buyers choose to have a pre-purchase inspection (PPI) done before the sale is final.” – JD Power & Associates.

Did you know that 1 out of every 10 used vehicles has hidden problems from its past? This well-known fact has led to the building of two successful businesses that assist the consumer when making a decision about a used vehicle. If you’re in the market for a used car and haven’t yet heard of CARFAX and AutoCheck, take notice. For just a few bucks you can perform your own PPI over the Internet.

carfaxCARFAX’s pitch is that you don’t have to rely on a stranger’s truth in advertising to find out about the mechanical and driving history of the vehicle they want to sell you. A CARFAX Vehicle History Report includes: 1) Title information; 2) Accident History; 3) Odometer Readings; 4) Lemon History; 5) Number of Owners; 6) Accident Indicators (like airbag deployments); 6) State Emissions Inspection Results; and 7) Service Records. All the critical information you need to avoid driving home with a lemony scent. AutoCheck tries to differentiate their service by attributing a score to each vehicle, although the services are basically one in the same.

“Many used car buyers quickly dismiss the thought of buying a CARFAX report because of the money, but let’s get real, the $25 spent on a quality vehicle history report is the best investment you will ever make. There are thousands, no probably millions, of drivers who wished they had spent the measly $25 to look into a car’s history instead of spending thousands of dollars on a car that has a damaged history, salvaged title, or is even a lemon!” – Jake Newberry, automotive industry insider.

So we’ve looked at three separate industries where big-ticket buying behaviors have driven the creation of tools and techniques that enable both sides of the equation to benefit. Athletes know what criteria they will be measured on and can train accordingly. Real estate agents know the impact a third party inspection will have on the transaction so the can gauge whether or not they want to provide it, or push it onto the uninformed buyer. And CARFAX has created a way for buyers to pull an honest background check in an industry where the deceptive salesman is legendary.

In each of these our last three blog posts, we see lessons from worlds of Real Estate, Professional Sports, and the Automotive Industry that need to be applied to early stage investing. These systems, tools, and processes ALL serve to accelerate trust and enable transactions. Entrepreneurs and investors, we hope you all took good notes.

If you’re interested in learning more about how a Venture 360 due diligence engagement can make you a more effective and efficient investor or entrepreneur, please contact us by sending a short email introduction to northventure360@dontgosouth.com and we’ll set up some time to talk shop.

Side Note; I also happen to know someone that is looking to purchase a used 2008 or 2009 Prius Package #5 in dark grey or silver. They’ll pay cash. And yes, they’ll require a VIN# as they’ll be conducting there own due diligence on the vehicle before they invest:).

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Professional sports franchises spend thousands of dollars on scouting, background checks, and running draft prospects through a series of mental and physical tests before they decide to invest millions of dollars. General Managers look at everything before risking their pick on an expensive draft pick. This is even truer when it comes to making a first round selection.

kwamemisseddunkTake the story of Kwame Brown. Back in 2001, the Washington Wizards had the honor of drafting #1 in the NBA Draft. With their pick they decided to choose Brown, becoming the first team to ever select a high-school prospect with the first overall pick. While still playing in the league, Brown’s career just never lived up to the hype. When drafted, Brown was 6-11, an imposing 250 pounds, and a gifted athlete. He was strong, had quick feet and a ton of potential. But after Washington selected him #1, many scouts said they questioned whether his small hands would hinder his play. They noticed in pre-draft workouts that Brown was having trouble catching passes and he missed quite a few dunks.

Small hands? Yep, out of all of the upside of this young man, it’s his small hands that wound up being the primary liability of this particular investment. With professional sports, like early stage ventures, you have to look at the entire investment (right down to the little details) before moving forward with a big decision. Sure, some mental and physical attributes can be suppressed or enhanced later on, but when that attribute is fixed, like hand size; you’re stuck with it. Ironically, whose decision was it to draft Brown? Michael Jordan. Yep, MJ was just given the title of President of Basketball of Operations and Brown was his first ever draft pick. So it just goes to show you, you can be the greatest basketball player of all-time and still be a mediocre evaluator of talent…

The National Football League (NFL) has developed a unique system for their 32 franchises to evaluate and score college seniors who may potentially become NFL players. “The Combine”, as it’s known, is a standardized system of physical and mental tests which, along with full medical examinations, gives teams a huge amount of objective and standardized data which they can use to weed out and ultimately select which players could be a potential fit for their locker rooms.

“I think it’s the total picture you get from the combine. The combine is another means of helping teams make good decisions, and the escalating cost of signing first-round draft picks makes the decision-making process all the more crucial. Teams spent a total of $160 million on signing bonuses for last year’s first-round picks. They want to make sure they know what they’re doing.” – Tony Dungy, Head Coach, Indianapolis Colts

peytonmanningryanleafIt also happens to be that Dungy’s former star quarterback Peyton Manning was part of one of the most well known draft debates of all time. Back in the 1998 NFL Draft it was all about who do you take #1, the safe choice with “pro-ready” skills (Manning from the University of Tennessee) or the wild card with all the upside (Ryan Leaf from Washington State). Most analysts agreed that Manning was the more mature player and should be the consensus top choice. Turn’s out they were right and then some. Manning just earned his third NFL MVP award to go along with his Super Bowl ring and Ryan Leaf, who played only 25 games in his career, has become known as one of “the biggest bust in the history of professional sports.”

Of course, each professional team has different wants and requirements, but the implementation of a standardized setting has allowed personnel directors the opportunity to systematically evaluate the upcoming draft class. Because the tests are standardized, the players are able to focus their efforts on performing well in specific areas. Obviously, there is no substitute for on-field performance, but for players coming from less-than-storied programs their performance at the combine can drastically improve their stock in the draft. The transparency of the system is what allows players to improve and provides them with instant feedback at to how they have done compared to other players.

What does this mean for the venture market? Well, consider the fact that in sports standardized tests like the 40-yard dash can be applied to all players. Coaches and scouts have a common benchmark upon which they can look at players from all over the country in a standardized way. What this system can offer is a way for scouts to filter out the over-hyped big school superstar, as well as discover that small school player with remarkable physical ability; an effective standardized measurement of a complex set of attributes. Who said football players aren’t smarter than Venture Capitalists?

Key takeaway; Don’t draft entrepreneurs with small hands? Nope. Before investing your time and money in a new innovative venture, conduct your own up close evaluation and make sure that venture’s strengths significantly outweigh its weaknesses. Wash, rinse, and repeat.

Excerpt taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

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homeinspectionreportNow ask yourself, would you buy a new home on a gut feeling or simply because the guy selling it says it’s a great deal? Probably not. A sensible real estate investor would probably evaluate every aspect of the property; from the foundation to the roof, the plumbing, the electrical, the lot size, the appliances, the paint, and of course the neighborhood. Even more likely, you’d probably pay for a professional home inspector (who sees thousands of homes every year) to come over, take a look, and give you a written report before you would sign the deed.

“A home inspection is perhaps the most important chapter in the home-buying process and can benefit both the buyer in understanding the condition of the house and the seller who wants to provide accurate disclosure information.” – Lynette Wyrick, PC from RE/MAX Equity Group.

Because buying a new home is most likely the single largest investment an individual will make in his or her life, it is difficult to remain completely objective and unemotional about a home that is seemingly perfect. Flaws get overlooked as judgment is affected.
hanselandgretel“Think you’ve found the home of your dreams? So did Hansel and Gretel. The fact is, every property has its dirty little secrets that only the owner knows about. In a perfect world, owners would come clean about the quirks and glitches in the old homestead when they fill out the property condition disclosure form that many states require. But as Hansel and Gretel found out, real estate is fraught with subterfuge.” – Jay MacDonald, Bankrate.com.

For accurate information, it is best to obtain an impartial, third party opinion by a professional in the field of home inspection. From a seller’s perspective, an objective inspection will provide valuable information and the opportunity to make repairs that will make the house more attractive to prospective buyers. A third-party objective inspection is therefore beneficial to both parties.

What’s interesting is that in some markets it’s standard for the seller to provide a detailed third party inspection to prospective buyers, while in other markets the buyer is the one who needs to invest in the inspection if they want to remove contingencies in their offer letter. The responsibility of who pays for the inspection tends to shift to the side of the market that has the upper hand at that particular moment. In the recent housing boom it was the sellers who got to push buyers with a “take it or leave it” attitude, today sellers are doing everything they can to make their property more attractive and they are now shouldering all sorts of costs, effort, and concessions that weren’t even on the table two years ago. What does that mean for raising investment capital? In today’s investing market the available capital is constricting while at the same time the pool of available deals is expanding. Will this shift some pressure (and costs) onto the sell side of the venture market like it has in the real estate market?

Note; one other insight that can be pulled from the real estate market is the standardization of deal documents and terms. The liquidity of real estate hinges upon the simplicity of the standardized paperwork. Just imagine the efficiencies that could be gained from standardized deal terms in early stage venture investing…

Key takeaway; neither entrepreneur nor investor are well-served by spending time and money focused on a new venture (or new home) that has bad DNA.

Excerpt taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

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Smart, wealthy, and very successful men and women lose billions of dollars every year investing in new ventures. Why? Recent research shows investors are often investing without first conducting their own thorough due diligence. Just how powerful is the connection between due diligence and investor returns? A recent three-year study of 539 Angel led investments conducted by the Angel Capital Education Foundation and the Kauffman Foundation, found an extraordinary correlation between due diligence and significantly greater returns.
beanstalk

“Spending time on due diligence is significantly related to better outcomes…investors who spent less than the median 20 hours of due diligence and investors who spent more, shows an overall multiple difference of 5.9X for those with high due diligence compared to only 1.1X for those with low due diligence.”Returns to Angel Investors in Groups, a comprehensive study of 539 Angel led investments. Robert Wiltbank, Ph.D. and Warren Boeker, Ph.D.,11/2007


Those numbers are staggering, not only in terms of the difference thorough due diligence makes, but the fact that the median of the study was only 20 hours, and that people are actually spending less time on due diligence than that! While this seems to support both the “follow the roar” and the “trusted referral” methods for selecting investments, this amount of due diligence is far less than most people would spend researching a major purchase. If you take a step back and think about situations in which an individual is preparing to spend a significant amount of money you see in each situation a unique standardized form of due diligence, and that spending a good deal of time on them is the norm. The goal of these efforts is to reveal any potentially damaging information regarding the item to be purchased as soon as possible. Or as Richard Drake of business law firm Womble Carlyle Sandridge & Rice explains, “a thorough review of what you are buying before it’s yours is the best insurance against any unwanted surprises down the road.” sharksighted


It’s time the early-stage private equity industry takes some notes and follows the models of other industries in which thorough due diligence is the norm (real estate, automotive, and professional sports). In the next few days, we’ll be walking you through each of these industries and illustrate how conducting the proper due diligence leads to increased returns. Each example boils down to the basic, easy to remember motto: cover your ass before you spend your hard-earned cash.


Excerpt taken from Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

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