Covid19 and due diligence

And what do VC and PE investors think about it

Better due diligence is not a buzz term.

It is exactly what investors should consider before investing in startups.

It’s not that all startups are bad, but only a handful some pick the winners while the others are left to pick up the scraps.

A buyer’s market

Looking at this buyer’s market, investors understand that the startups’ fundraising process may take longer.

Despite the usual rubbish which an investor may hear, it is not because “there’s no money”.

It is because investors had started to run better due diligence on their future deal flow.

Bringing “junk” for co-investment during the Covid19 epidemic (and post it), would definitely be the end an investor’s career.

Why?

Because there is absolutely no reason to waste time on dead weight.

Unscaleable projects

Unscalable projects are all those startups that promise one thing and can never deliver.

They are also the ones which often tell investors there is a huge market and no competitors.

Are the ones that say “5% is the max I’m going to give for this”, even though their valuation makes no sense.

These are also the projects which bleed money like there’s no tomorrow and keep on raising funds.

Covid19 has taught investors that these “won’t cut it” anymore.

How to spot a bleeder

A bleeding startup is easy to spot:

  1. It has invested money out of its own pocket but still took grants from whomever
  2. It has no traction, no users, no paying clients
  3. It’s in a perpetual “we have pilots with Fortune1000s” limbo
  4. It keeps going to startup competitions for any possible money
  5. Its business model is too intricate to understand
  6. Any money that was invested in it was already spent
  7. Its burn rate is sky-high
The “traction theorem” from AJ’s post on Linkedin

How to avoid the bleeder

If an investor has already invested in such startups, there needs to be a bandaid on.

The investor needs to create a better milestone plan to avoid bleeding profusely.

The investor needs to rethink the equity basis; 30% equity in nothing, still equals nothing.

The investor needs to know when to shutdown the business if needed, based on clauses in the term sheet.

Better due diligence

Sometimes, investors receive a lead through one of their colleagues, partners, whichever.

Investors could then be lured into speaking with a future bleeder and end up spending unscrupulous amounts of time (and money) on something that could never scale upwards.

Nepotism is also a sign of saying “no”; if this startup was invested a sum by a known businessperson, one should always check who that person was.

Some people believe in raising money for the team, despite the startup having no future value.

These all are bad signs.

These all bring in bleeders to the equation.

Getting rid of the bleeder

All money invested is now sunk.

The investor is now considering the next steps.

Investing even more money would be impractical.

But there is another way, the private equity way.

If the PE investor would collaborate with the VC investor, there may be a win-win.

The VC investor would still gain 100%-200% of its original money.

It’s not the same as an “exit”, because private equity are no fairy-tale ending.

They are usually the end for certain startups.

Why should anyone buy a bleeder

Deepak Shukla, a known entrepreneur, has actually bought out a good couple of companies within the last two months or so.

The reason being – doubling-down.

When asked about it, he simply explained that starting a business is more difficult than buying it:

  1. Registration of a new business
  2. Branding and overall marketing
  3. Hiring personnel to run it better

Naturally, he was referring to digital businesses, such as affiliate websites, social media agencies and the likes.

But, these may be applicable to almost any other business out there.

We also think that #4 should be “enjoying tax breaks”.

This option may get an investor to put money straight into a running operation without needing to waste precious time (and money) on expensive legal-suite.

Sometimes, the bleeder becomes a division in the buying out company.

It may seldomly be cut into pieces and sold separately (Motorola is a good example).

Perhaps, the buyer is also looking to get into a market that is relatively unknown to it.

Not all bleeders have no good product; they just lack good execution.

A good investor needs to spot the executioners and deliverers and avoid the big-talkers.

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