This post is a preview of an upcoming white paper on the topic of early-stage startup due diligence.
There are plenty of articles and surveys on the topic of startup failures and how the venture capital industry simply assumes most startups will fail and only a small percentage will achieve a large exit.
Dealroom, in 2020, found that a startup's chances of exit nearly double if it can raise another round (e.g., Series A) past the seed stage. So, we know it is critical for a startup to get past its seed stage, find product-market fit, and raise a meaningful VC round.
There is less research out there about why startups fail. Wilbur Labs analyzed data from CB Insights and Autopsy and found that the top three reasons were:
We would argue that these are all basically the same reason: startups run out of money because they failed to plan appropriately, or investors didn't have faith in the team and their plan. Or both.
Why Startups Fail
We know that startups will likely fail before raising [x] in funding.
And startups who fail do so primarily because they do not have an adequate plan.
We also know that startups at this stage are raising money from angels, friends & family, and other pre-seed sources such as accelerators/incubators/etc. These sources are usually betting based on the story's strength or their faith in the founders (they don't typically have the resources to efficiently analyze or coach on a detailed business plan or financial model).
In fact, quite a few pre-seed and seed-stage investors see due-diligence as essentially a waste of time ("why do this analysis when the startup hasn't even found product/market fit yet?")
We believe in due diligence because
It gives us good insights into the team's strengths
It tells us the attractiveness of the market
It is an excellent way to distinguish high-potential startups from those that will quickly run out of runway.
This is why we designed our due diligence program the way we did.
How Sente's Due Diligence Program Benefits Startups - And Investors
We have a standardized, 5-week collaborative program that touches on all critical aspects of a startup's market, team, business model, financial model, and comparable companies. We believe this is important for our own selection process and our investing partners' decisions.
This process is an important experience for startups to go through to plan, estimate resources, and defend their plan and strategy with investors.
But don't take our word for it: this month, we surveyed 24 entrepreneurs who have participated in our programs in the past three years. This survey also included startups who did not proceed to Phase 2 of our program (i.e., were not selected for investment).
What we learned was not a big surprise. The vast majority believed they emerged stronger than when they came in. More importantly, you can see that the startups who raised money after the program ended were more likely to have gotten value out of key aspects of the program (such as capital needed).
We have been able to strike a balance.
Unlike startup accelerators with structured, standardized education modules, our deliverable-based approach allows our analysts and startups to focus on items that need the most attention. Most "demo day" approaches focus mainly on storytelling via the pitch. Our entrepreneurs become more confident because of their stronger plan rather than a smoother story.
Our approach gives us much better insights into the character and capabilities of the founding team. We establish a strong relationship with the team that pays off when they are selected for investment and continue on their journey with us.