Raising Your Hand as Due Diligence Lead for Angel Groups
Through Rob Wiltbank’s ground-breaking study in 2007, angels in groups learned that collective due diligence on new deals really pays off. The 538 angels included in this study enjoyed 2.6X returns over the life of their investments. However, for deals on which collective due diligence totally less than 20 hours, returns were only 1.1X. But, deals on which angel put in over 40 hours of due diligence (the top quartile) returned 7.1X to angel investors. Due diligence clearly makes a big difference for angel investors.
Let’s drill down a bit. Entrepreneurs pitch to angel groups and, for those deals of interest to the members, a due diligence team is formed. Angel members self-select by volunteering to join the due diligence team. OK…in some cases members are recruited to join the team, because (1) they understand the business vertical of the target company or (2) they are known within the community to be good at due diligence. Finally, one of the team “raises his or her hand” and volunteers to lead the due diligence. Well…perhaps that member’s other arm may have been twisted a bit to take on this due diligence chair position.
Sometimes it is difficult to find a lead or chair of the due diligence team. Why? Typically, members state they don’t have the necessary time to manage this activity at the moment. Or, perhaps the member is not comfortable with a “deep dive” into a business in this particular business sector. Both are reasonable excuses that angel group leaders hear all the time.
There is another oft-times unspoken reason. Due diligence lead is time-consuming, but much more so than is necessary to close the deal. More often than not, the due diligence lead is asked to serve as lead investor of this round and then join the board of directors of the invested company. By agreeing to serve as due diligence chair, the member has not only volunteered to lead a two-month, relatively exhaustive due diligence effort, but then step in as lead investor for multiple terms as a company director; perhaps total of 5-10 years of engagement! No wonder experienced due diligence leads must have their arms twisted to step into this role!
Is there a better way? I think so. I find that some of my fellow angels are really bulldogs as due diligence leads but not the best possible startup directors. Others group members are not the best at leading a due diligence effort for the group but are wonderful directors for startup companies. Leading due diligence for angel groups requires specific project management skill sets – getting a job done is a limited amount of time. Lead investors generally enter into longer term relationships with portfolio companies and often require entirely different life experiences. Why tie these roles together?
I would propose that angel group leaders specifically separate these roles. Make it the responsibility of the due diligence committee, working with the angel group leadership, to select the most qualified member to serve as lead director for group investments. Does this mean that no one who serves as due diligence chair can ever serve as lead investor? Of course not! But, offer the lead investor position to one who has significant experience in startup boards, soliciting follow-on funding and teeing up companies for exits, regardless of their willingness or availability to serve on the due diligence team. I believe this tactic will make it easier to solicit members to lead due diligence teams.
Written by Bill Payne
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