Angel investors and venture capitalists looking to put money into new projects must do their due diligence. Sometimes they handle it in-house. Other times they contract with companies like Utah-based Mezy. When due diligence is outsourced, the quality of the services provided makes an enormous difference.
Due diligence is the process of looking at every aspect of an investment to determine whether or not to proceed. Due diligence looks at past performance and future potential. It looks at financials, products, and services, the management team, the workforce, etc. Data is compiled into a set of due diligence reports investors use as the basis for their decisions.
It goes without saying that the quality of the data that investors receive matters. Investors do not want to make decisions based on bad information. To further illustrate the point, here are five reasons they scrutinize the quality of their due diligence providers:
1. Fraud Is Always a Risk:
The vast majority of projects investors put their money into are legitimate. Some may fail, but there was an honest attempt to make a go of it. On the other hand, fraud does exist. A case in point is Theranos Inc., a California company that ultimately bilked investors out of some $600 million.
News reports suggest that investors should have been suspicious of Theranos all along. But far too many of them jumped in without doing their due diligence. Even among those who did conduct due diligence, some were working with low-quality data.
2. Consolidation and Fragmentation Concerns:
Industries naturally start out fragmented before trending towards consolidation. Quality due diligence is necessary to determine how the level of fragmentation or consolidation will ultimately influence future returns. In many cases, consolidation is problematic.
Consider a company wanting to compete with Amazon. The retail giant has such a stranglehold on its particular industry that attempting to compete is a fool’s errand.
3. Management Teams Truly Matter:
A big part of due diligence is looking into the management team’s history and experience. The information gleaned really does matter.
Because even the most promising business model can be left shipwrecked by an incompetent management team. Moreover, it is easy to overlook a suspect management team after sitting through a flashy pitch that leaves dollar signs in your eyes.
More than anything else, the management team can make or break a new enterprise. This is one particular area in which investors cannot afford shoddy data. They need to understand management teams in every possible detail.
4. Financials Only Go So Far:
High-quality due diligence reports cover a lot more than company financials. It is a good thing because financials only go so far. You know what they say in the investing world: past performance is not an indicator of future returns. That old adage takes on new meaning when investors are considering startups. The newer the company, the less historical data there is to work with.
5. Investment Opportunities Abound:
Finally, experienced investors know that opportunities abound. There are so many that it is just not possible to get involved with all of them.
Therefore, investors rely on due diligence reports to determine which opportunities are best. The higher the quality of the data, the easier it is for investors to separate the best opportunities from all the rest. And when the goal is to maximize returns, investors want to be able to do that consistently and effectively.
Investors should always take due diligence seriously. They rely on high-quality data to make important decisions. That’s why so many are so quick to scrutinize due diligence service providers.