Due Diligence of personal lives of Founders, new aspect of Startup Funding

 

“An investor invests in the team and not the company”. Lord knows how many times I keep writing this everywhere and in everything related to startup funding. The current newsflash this morning in Economic Times has now sealed the argument. The hot shot investors like Sequoia Capital, Kalaari Capital, Helion Venture Partners, Nexus Venture Partners and Accel Partners, are increasingly running checks on the personal lives of entrepreneurs, wary of extravagant, reckless, raucous behavior, before funding them, says this Article. 

This is not a new element. Before every substantial deal, a background check is always conducted in order to assess the financial credibility of the company AND the founders. However, the news of checks on the personal backgrounds of promoters has indeed created a rumble. However, the crude fact is that most of the deals conducted last year were sealed only after a personal due diligence check on the founders of the startup.

This being considered as poaching on privacy by many. However, behavioral science and study of human aspects in entrepreneurship is not a new concept. The only change we are experiencing is in terms of increasing numbers of these tests.

Why this sudden spurt in Founder’s Due Diligence?

The answer lies in the curious case of startup investor relationship. Once bitten twice shy. This, I guess, is what is going on in the minds of the investors. The rapport of the founders with their investors, the work culture and team sync of their entity pre and post funding are being closely monitored by investors. Reference: the tale of Rahul Yadav and his Housing.com!

There are various factors that fueled the growth of this unique Due Diligence test, like:

• Many times it is seen that the promoters or the upper rung of management get to go home with fat packages whereas the startup itself is just in the budding stage. This leads to an undue pressure on the profitability and sustainability of the entity. The investors would definitely not be comfortable eroding their resources on the Founders and his team, especially where the startup itself is starving. 
• Some startups have started up in order to get funding! So much so that once they get the seed funding, their next set milestone is Series A. The passion for growing their business, developing their product, innovate their services offerings take a back seat. Yes, this is the true picture! There is no denying this. 
• Internal tiffs among co-founders are not visible apparently when a startup negotiates the term sheet with the investors. Now, the investors are in for a rude shock while finalizing the Shareholding Agreement, when one or few of the co-founders deny agreeing to terms. By this time, a lot of time, effort and cost already get incurred. This entire fiasco can be avoided by a background check on the promoters. 
• We live in a world which runs on connections and networking. Many businesses survive on networking. Now, it may so happen that the Founder of the startup may have negative impression in the circle. This would definitely set the reputation of the startup at a back footing. 
• Another argument favored in this regard is that the lifestyle of the Founder impacts the morale, ethics and work culture of his team. A founder is the face of his startup. No investor wants a cheeky Founder with big talks and no returns. His raucous lifestyle, dubious public image, impulsive decisions might be key factors in determining the destination of his startup.

It is better to have all hands on deck before the winter comes. The investors seem to be thinking in the same lines as RR Martin. What impact will this have on the supposed Investment bubble? Only time has the answer. As of now, we can only suggest the Startup founders who are planning a pitch. There is a load to do and not just in figurative terms.

Get Internal Due Diligence done for your startup! Visit Taxmantra Funding & Term Sheet Assistance page for any assistance related to Funding and Due Diligence.

 

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