Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups

8

Look Under the Hood and Lead a Deal

Coordinating Due Diligence and Running the Show

ONCE YOU'VE DETERMINED that a startup has the qualities you seek in an investment—a great entrepreneur, a solid business idea, impressive growth potential, a viable plan for attracting customers and generating revenue—you should verify that appearance and reality are one. In the business world, this is called doing due diligence. The term is derived from a section in the Securities Act of 1933, which says that as long as broker-dealers exercise due diligence (i.e., appropriate care and effort) in their investigation into the company whose stock they are selling, they are not liable for nondisclosure of information that they did not discover. Over time, this was shortened to the two words, and today “due diligence” refers to the practice of carefully checking the details of claims made by any company.

Due diligence is not always a simple matter. In an investment round made up of Accredited Investors, there is no legal requirement for the entrepreneur to provide a prospectus or any specific disclosure schedule, and they are therefore rarely, if ever, provided for an angel round.

Where schedules and lists do appear, however, are in due-diligence requests or checklists from serious investors, which the investors' counsel provide to the company prior to closing. Depending on the size of the round and the size and professionalism of the investors (and the budget of their lawyers), the requested information ...