Early-stage companies are difficult to evaluate as the business skill level of company founders varies widely and there is no playbook or hard and fast metrics to follow. The industry commonly attributes success to pattern matching and while experience often helps in assessing a team’s drive and staying power, the fact is that most early-stage ventures – at least the game changing ones – aren’t based on replicating Pinterest or building SnapChat 2.0. They are novel ideas often in new markets and they require investors to roll up their sleeves, raise red flags, and ultimately invest only if they can build a thesis for the future of the market and why this particular venture is going to succeed.
And the hard work pays off. Historical studies and anecdotal evidence indicate that early-stage investments returns are positively correlated with quality analysis. In the most recent available study by Wiltbank and Boeker, investors who spent more than 20 hours conducting due diligence achieved 5.9x returns while investors who spent less than 20 hours conducting diligence only obtained 1.1x returns.
At a high level, investors are asking a) how big is the opportunity, b) can this particular team execute, and c) are the deal terms fair. The analysis grid below provides more concrete insight into the analysis process. It is not meant to be comprehensive; instead it is intended to provide color on the specific questions that skilled early-stage investors may ask and the types of responses they often hear. Specific company statistics have been altered to conceal company identity and protect proprietary information.
The takeaway: analysis, while challenging, is critically important to overall portfolio returns.