Lesson 5: Due Diligence Deep Dive — What Really Matters

Jan 12

You've learned the fundamentals of angel investing and the mindset required for success. You understand that diversification is your primary tool for managing risk and that your value-add is a critical part of the "smart money" you provide. Now, we arrive at the most important, and often most rigorous, stage of the investment process: due diligence.

Due diligence is the process of thoroughly investigating and verifying all material facts about a potential investment. For angel investors, it is a systematic approach to asking hard questions, scrutinizing claims, and confirming that the opportunity is what it appears to be. While the term may sound intimidating, effective due diligence is simply about gathering enough information to make an informed decision—a skill you already possess from your professional life.

Due diligence is the single most effective way to mitigate risk and increase your chances of a successful outcome. It is where you move beyond the excitement of a pitch and into the rigorous work of evaluating a company on its merits.

The Role of Spark Angels in Due Diligence

At Spark Angels, we understand that due diligence can be a significant undertaking, especially for an individual investor. This is where the power of our group truly shines. We operate on a collaborative model where we leverage the collective expertise of our members to make the process more efficient, insightful, and accessible.

Our Process is Designed to be Collaborative, Not Overwhelming:

Spark Angels Leads the Process: For each deal presented to our group, a dedicated due diligence lead or team is formed coordinated by the Spark Angels Executive Director. This team, composed of interested members, is responsible for coordinating the investigation, creating a list of key questions for the company, and organizing all the information gathered.
We Lean on Member Expertise: This is where your unique background comes into play. If a deal is in a specific sector—say, health tech, B2B software, or consumer products—we actively seek out members who have relevant domain expertise. Your professional experience is invaluable here, whether it’s in marketing, finance, legal, technology, or operations. You are encouraged to join the due diligence team, share your knowledge, and ask the tough questions.
Encouraging Member Participation: The due diligence process is a core benefit of being in an angel group. You are encouraged to review the company's materials, attend meetings with the founders, and contribute your unique perspective. This is how you learn from your peers and build confidence as an investor.
The Goal: Our collective effort provides a robust, shared foundation for every member. This means you don't have to start from scratch. You can review the team's work, contribute as much or as little as your time allows, and use the collective findings to inform your personal investment decision.

Ultimately, while the group facilitates the process, each individual investor is responsible for their own final decision. Our role is to provide you with the tools, information, and collaborative environment to make that decision confidently.

A Comprehensive Guide to Due Diligence: The Key Pillars of Evaluation

Effective due diligence can be broken down into six core pillars. For each, the goal is to validate the founder's story with concrete evidence.

1. The Team: "Bet on the Jockey, Not the Horse"

In early-stage investing, the team is often the most critical factor. A great team can pivot from a bad idea, but a weak team will fail even with a great idea.

Experience & Track Record: Do the founders have relevant industry experience? Have they successfully built and sold a company before? If not, what have they achieved that demonstrates the skills and resilience required to build a startup?
Cohesion & Culture: How well do the co-founders work together? What are their individual strengths and weaknesses? Have they established a strong, positive company culture?
Coachability & Integrity: Are the founders open to feedback from investors and advisors? Do they listen to their customers? Do they demonstrate integrity and honesty, especially when things are going wrong?
Advisors & Board: Who else is on the team? A strong, engaged advisory board can signal credibility and provide valuable guidance.

2. The Market: How Big is the Opportunity?

The market provides the canvas for a startup's potential. Due diligence here is about validating the size and dynamics of the market the company aims to serve.

Market Size: What is the Total Addressable Market (TAM), Serviceable Addressable Market (SAM), and Serviceable Obtainable Market (SOM)? Does the founder’s market sizing methodology seem realistic and well-supported?
Trends & Growth: Is the market growing or shrinking? What macroeconomic, demographic, or technological trends support the startup's growth?
Problem Validation: Has the problem the company is solving been validated by actual customers? Do customers feel this problem is urgent enough that they are willing to pay for a solution?

3. The Product & Technology: The Competitive Moat

This pillar focuses on the product itself and the technology that powers it.

Uniqueness & Defensibility: What makes the product or service unique? Is there a proprietary technology, a patent, a unique algorithm, or a network effect that creates a "competitive moat" to protect the business from competitors?
Development Stage: Is the product still an idea, a prototype, a Minimum Viable Product (MVP), or a fully-featured product? How much work remains to reach scalability?
Customer Feedback: Has the company conducted customer interviews or surveys? What are customers saying about the product? What are their usage habits?

4. The Business Model: How Will Money Be Made?

This is where you scrutinize the company's plan for generating revenue and achieving profitability.

Revenue Streams: How does the company plan to make money? What is the pricing model? Are there multiple revenue streams?
Unit Economics: What is the Cost of Customer Acquisition (CAC)? What is the Lifetime Value (LTV) of a customer? What are the gross margins? Do these numbers make sense and demonstrate a path to profitability?
Scalability: Can the business model scale effectively? What are the key milestones that will enable the company to grow exponentially?

5. The Financials: "Show Me the Money"

Financial due diligence for an early-stage company is often more about understanding burn rate and runway than past profitability.

Current & Historical Financials: Review any available historical financial statements (income statements, balance sheets, cash flow statements). Are they accurate and well-maintained?
Financial Projections: Are the financial projections realistic and based on sound assumptions? Do the founders have a solid grasp of their numbers?
Burn Rate & Runway: What is the company’s monthly "burn rate" (the rate at which they spend capital)? Based on this, how long is their "runway" (how many months of cash do they have left)?
Use of Funds: How will the new capital be used? Does the use of funds align with the company's stated milestones and goals?

6. Legal & IP: Protecting Your Investment

Legal due diligence ensures the company has its "house in order" and that your investment is secure.

Corporate Structure: Is the company a C-Corp? Are its articles of incorporation and bylaws in place?
Cap Table: Is the capitalization table accurate and easy to understand? Are all shares accounted for? Are there any unvested founder shares?
Intellectual Property (IP): Does the company own its core IP? Are there any patents, trademarks, or copyrights? Have all employees and contractors signed IP assignment agreements?
Legal History: Are there any past or pending lawsuits, legal claims, or regulatory issues?

Conclusion

Due diligence is the cornerstone of successful angel investing. While it requires a disciplined and thorough approach, the collaborative model of Spark Angels makes this process both manageable and insightful. By leveraging the diverse expertise of your fellow members, you can move from a state of curiosity about an opportunity to a position of informed confidence, empowering you to make a final investment decision that is grounded in facts, not just feelings.