From Dilettante to Diligence

Phil Southward

“Diligence is the mother of good fortune.” 
― Miguel de Cervantes Saavedra

“Diligence without intelligence is tragedy, not success.” 
― Kevin Keenoo

My first 'angel', a stretch of the word in every sense, startup investment was unaccountably, to the many who questioned it, more dilettante than diligent. But then contrary to the core, I knew a good thing. After all, having attempted to found a company in 2001 along the same lines, I must be an expert. And their product was far better than I had ever imagined ours to be. Plus they were working agile, when hardly anyone else was. So I met with the founder for a coffee and a chat. And invested. And doubled down. Twice. Due dilettanteness at its finest. 

​dilettante
	​NOUN 1 A person who cultivates an area of interest, such as the arts, without real commitment or knowledge. 1 ‘there is no room for the dilettante in this business’​
	​SYNONYMS dabbler, potterer, tinkerer, trifler, dallier amateur, non-professional, non-specialist, layman, layperson ANTONYMS ​professional (1)

As I know now, I was lucky. Dilettante lucky. Lucky that first investment turned out to be one for the books. Lucky because many angel startup investments are impervious to a Midas touch. For example one British study has shown that in 47% of investments, business angels have a partial or total loss, while on just 23% of investments, they earn an internal rate of return (IRR) of 50% or better. (2) While in another, this time US based, study of angel investors, it was found that two thirds of investments by business angels fail and an IRR of more than 100% was earned on just 20% of investments. (3)
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The good news for us dilettantes wading through the wowsers of the academic literature, however is that a number of other studies have determined business angels are a highly influential, perhaps even critical factor, additional to the finance they bring, in the success of startups they invest in (2;3;4;5;6). Smart money in deed, where angels, as Wiltbank and Boeker found in their widely cited 2007 research paper, positively influence startup investment returns by:

• Performing due diligence. The more time spent doing due diligence, the better the return. 
• Investing in the same industry segment as their work experience.
• Hands-on activities with the startups, such as coaching, mentoring, access to business networks and performance monitoring. (6)

While some angels don't dig due diligence and occasionally put less experienced dilettantes, like me, to shame by having successful exits anyway, research by the British Business Angels Association concludes those angel investments where the angel undertook at least 20 hours of due diligence result in significantly fewer failed investments than those with little or none. (7) 

Ok so it seems the odd, but definitely not strange, person thinks a bit of due diligence is not such a bad idea. But what is this due diligence thing exactly? Let's start by making clear what due diligence is not. It is not listening to the inner FOMO (fear of missing out) and piling into a hot deal solely because others are, no matter how renown they might be:

"The biggest sin committed by investors is simply relying too heavily on their peers’ reputations as a form of due diligence. (It is not.)". (8)

Take the 2013 raise for Clinkle, a payments startup as detailed on TechCrunch. This deal was promoted at the time as being the largest seed round ever in Silicon Valley with a number of big name investors and venture capitalists, including Intel, Intuit, Andreessen Horowitz, Accel Partners, Marc Benioff and Peter Thiel. Two years later, however, the company had collapsed, the USD 25 million seed now rooted.​ (9)

Nor is due diligence a sales process. It doesn't occur with the purpose of producing a 'sales document' to convince others to invest, as I heard one overly enthusiastic lead investor state. Finally due diligence is not about paralysis by analysis. Endlessly examining every minute part of a startup over and over until all risks of a possible investment have been eliminated and the perfect company unearthed. If that was the aim, no due diligence could ever recommend an investment. All startups have flaws. If they didn't, they wouldn't be startups.

​due diligence
	NOUN law ​1 Reasonable steps taken by a person to avoid committing a tort or offence. 1.1 A comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential. (10)

Due diligence, at least as this long time dilettante sees it, has two objectives. The first is to identify any show stoppers. The critical flaws that either can't be fixed or will take so long to do so, the startup will never deliver a reasonable return on money invested. Coming a close second is determining which non-critical flaws can be improved and how. The typical Flying Kiwi Angels (FKA) due diligence team focuses on these objectives while diving deep into:

• Team - what are the capabilities of the founders and team, how coachable are they, what experience do they have, can they execute, …
• Market and competition - how big is the market and what competitors does the startup have.
• Product - what is the customer problem or pain being resolved, how does the product resolve this problem, has this been validated, product architecture, product strategy, …
• Business model - how does the startup plan to make money, what is the business strategy, what sales channels will be used, …
• Customers - who are the customers and how many are there, customer experience of the product and company, …
• Operating the business - what functions and processes exist, how is operations handled, what technology is used, can the business be scaled, …
• Finance - revenue, profit margins, LTV, CAC, ARR, costs, burn rate, …
• Funding and valuation - current capital structure / ownership, valuation method used, exit strategy, potential future valuation, …
• Risk and governance - how is the company currently governed, who are the directors and what are their capabilities, what major risks exist, how can these be mitigated, what IP is in the business, …

Provided nothing stops the show, the FKA team conscientiously condenses their findings in a suitably sectioned 'warts and all' report. By being diligently devoid of conclusions on investor reputations, such a report provides useful information for potential investors to begin their own independent interpretation of the merits of any investment.
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At the risk of sounding like a devoted diligent, I'm now on my fifth due diligence team this year and having great fun. Yes that's right, as geeky as it sounds, fun. Oh of course it can be hard work with lots of late nights and early mornings, especially when the startups are in New Zealand and I live 18,000 km away in Munich. Despite that I get to (e)meet some really clever, interesting people from both sides of the fence, learn a lot and sometimes I even get to give something back. Dilettantes be damned.

References

1. https://en.oxforddictionaries.com/definition/dilettante
2. Mason, C., & Harrison, R. T. (2002b). Is it worth it? The rates of return from informal venture capital investments. Journal of Business Venturing, 17(3), 211–236.
3. Wiltbank, R. (2005). Investment practices and outcomes of informal venture investors. Venture Capital, 7(4), 343–357.
4. Kerr, W., Lerner, J., & Schoar, A. (2014). The consequences of entrepreneurial finance: Evidence from angel financings. Review of Financial Studies, 27(1), 20–55. 
5. Riding, A. (2008). Business angels and love money investors: segments of the informal market for risk capital. Venture Capital, 10(4), 355–369. 
6. Wiltbank, R., & Boeker, W. (2007). Returns to Angel Investors in Groups.
7. Wiltbank, Robert E., "Research report: May 2009 Siding with the Angels", British Business Angels Association & Nesta, May 2009. 
8. Loiszos, Connie, "The truth about due diligence", TechCrunch, May 19, 2016, 
9. Constine, Josh, "Flaming Wreckage Of Clinkle Rebuilds As A Referral Service", TechCrunch, December 29, 2015. 
10. https://en.oxforddictionaries.com/definition/due_diligence 

Phil Southward, originally from Wellington, is a recovering dilettante and angel investor.
He's also written a book The Soaring Kiwi & the Sauerkraut about his experiences of marrying a grumpy German and moving to Munich to fly hang gliders as often as he can. Phil can occasionally be found lurking on Twitter as @KiwiSauerkraut.

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