Building Wealth through Venture Capital

CHAPTER 9The Final Exam: Due Diligence

Venture capitalists are both hunters and gatherers. They seek out the best and the brightest among entrepreneurs and their ideas. Once they have an initial intuition that they have found a likely winner, they go into data gathering and analysis mode, which in the industry is known as due diligence. All professional VC investment firms perform due diligence to some extent.

Is Due Diligence Really That Important?

How critical is due diligence to the probability of investment success? Since most VC investments fail, might rigorous due diligence be just a waste of time? Are there too many variables and chance events, particularly in a seed‐ or early‐stage investment, for diligence to tilt the chances of success one way or another?

Some might argue that diligence doesn't really matter in the long run and that investment outcomes are mostly a function of luck. Isn't this much like what we've read in history books about Napoleon—that in order to win his battles, his biggest desire was for lucky marshals to lead his troops? There is little hard research evidence that the degree or competence of the diligence improves the number of wins for a VC firm. Even for many of the biggest and best‐known VC firms, only about 15–20% of all their investments make any money at all, and lots fewer are home runs.

Does diligence help pick winners (or reduce the number of losers and the magnitude of their losses) or just provide false comfort for the naïve? ...