I t is no secret that venture capital is being invested in greater volume and at higher speed than ever before. Last year a record amount of VC money was committed, over €100bn, to startups in Europe and Israel. Some of these investments were done at a pace that would once have been unimaginable: the French NFT platform Sorare, which raised a European record $680m Series B round last September, received a termsheet from one investor within 48 hours of first meeting them.

A company in our portfolio similarly signed a termsheet for a $50m round just 6 days after meeting the new investor. For startups with a good story to tell, capital has probably never been more freely available.

In many ways this is a positive development, promising to consign to history the days when VCs would drag their feet endlessly over investments. But there can also be a risk, and a cost, to doing business fast. That is especially true if speed comes at the expense of two key components in any investment: due diligence (DD) and a relationship built on mutual trust.

In many ways this is a positive development, promising to consign to history the days when VCs would drag their feet endlessly over investments. But there can also be a risk, and a cost, to doing business fast. That is especially true if speed comes at the expense of two key components in any investment: due diligence (DD) and a relationship built on mutual trust.

DD often gets a bad name — deemed cumbersome, time-consuming, one-sided and ultimately disadvantageous to founders. But it is both more important and less troublesome than many assume it to be. Slimming it down or skipping it altogether will invariably be a false economy. Any time saved during the investment process will be lost many times over at the operational stage, as founders and investors spend their early board meetings getting to know each other, dealing with basic questions, and gaining overall alignment: work that should have been done during due diligence.

It is not just wasted time but lost returns that can be at stake, both for founding teams and investors. A 2007 study of angel investors found a divergence in exit multiples between those who did less than the median level of DD (20 hours) and investors who had committed much more. The ‘high diligence’ group returned an average of 5.9x their capital, compared to 1.1x for their ‘low diligence’ peers.

The disparity may not always be so stark these days, but as investors we know the critical difference that DD can make. Today, when we back a company as a primary investor in early-stage rounds, we may only have 6–12 months to provide practical support to founders before they kick off fundraising again. Effective DD is what allows us to hit the ground running and make the best possible use of precious time.

Diligence done well

The importance of effective DD does not mean it should be allowed to slow down the investment process. We believe as much in the advantages of working quickly as we do in the value of due diligence. In today’s market, the real question is how DD can be adapted to fit the faster pace of dealmaking.

In our experience, this requires the right work to be done on both sides of the table. To get DD completed at lightspeed, everyone needs to enter the conversation well-prepared. As investors, it is our obligation to form a view on the product, market and to some extent team before we first meet the founders. At Beacon, we do this by keeping a forward calendar of companies we might engage with in each of the next four quarters, continuously tracking their digital footprint and talking to their founding teams. We generate internal company scorecards for every team we meet, which we update at every step of our DD process (see our template here). These signal areas where we need to dig deeper and further our understanding, helping to prioritise any further requests for information.

By the same token, we expect founders will have their documentation, research and insights ready to hand. In the interests of speed, founders can provide valuable shortcuts to investors: for example, categorising and interpreting relevant research and market insights, summarising financial data with relevant charts, and establishing well-defined cadences for the raise.

DD is not just about scrutinising historic data. It can also play a key role in setting benchmarks for the future. At Series A, financial metrics are often ‘noisy’ at best, but we do not consider them irrelevant. In many cases, we use them to understand what performance metrics we should be tracking in the 12–18 months following the investment (generally using this template to initiate our discussions). Agreeing these priorities at the earliest stage can be key to achieving top decile performance, making it more likely that a company will attract high-quality investors in subsequent rounds. Again, this is an example of where doing the important work at the DD stage can plant the seeds for success later on.

As founders undergo DD, it is worth considering where all the information and insight they provide is ultimately going — the investment memorandum (IM) is what 99% of funds use to distil and present the case for funding a company to their investment committee (IC). At Beacon, we use a 10–12 page document that attempts to answer key questions around the main pillars of the business and its market: the market (not as is now, but as it will be in 5 years), team (what they know that others don’t, their ability to attract top talent without paying top dollar), product (can they build a category? How big can the product’s footprint become and how fast?), and traction/financials (quality of forward SaaS metrics; ability to grow revenues +3x yoy and at later stage grow the revenue multiple too!).

Founders do themselves a big favour when they are not just giving the best account of their business as they see it, but anticipating investors’ questions before they are asked. Preparing a strong data room as part of the fundraising prep work goes a long way to making sure you have the necessary scope of materials ready.

We believe founders should consider DD as an opportunity and not an obligation: part of the process that exists to help them as well as their potential investors. It is a process we encourage founders to own and be proactive in, asking questions and doing their own validation of a potential long term partner. We would no more advise a founder to accept a hastily-issued termsheet without doing their own DD than we would choose to invest this way ourselves.

Before accepting any termsheet, founders should also ask for references from existing portfolio companies and consider requesting introductions, or any other form of support, to validate if an investor is willing and able to open up their network and spend time with them.

Similarly, any founder who does not ask key questions such as the investor’s fund size (what kind of outcome will the fund be looking for?), ticket size (are they a candidate to lead the round?), track record (do they have other successful investments from where to share best practices?), and value-add (tangible examples of how they do that and cross reference these by talking to portfolio founders) does so at their own peril. These are not just relevant questions for a first call but also worth asking and re-validating at every subsequent stage.

A stitch in time

In a fast-paced VC market, there is inevitably pressure on all sides to get an investment done quickly. That is a useful imperative, but it should not be achieved through shortcuts that only create problems for the future and put the long-term health of the company in jeopardy.

Founders and investors both lose out when an investment goes ahead without anyone having put in the effort to ask hard questions and surface potential challenges. The later in the process these are addressed, the harder and more costly in time and energy they usually are to resolve. By contrast, when the difficult issues are tackled early on, the road ahead begins to clear and the chances of a successful partnership increase in turn.