The amount of due diligence that angel investors conduct on the start-up businesses they’re considering funding can mean the difference between gambling and investing, according to a panel of experts.
“There are a lot of skeletons that due diligence can bring out of the closet,” said Elizabeth Kraus, co-founder of the Impact Angel Group, a Boulder, Colo.-based network of investors dedicated to making a positive social or environmental difference, while earning a profit.
Among the discoveries she’s made while investigating angel investing candidates are a founder with a history of tax evasion and a start-up that falsified product performance data.
“Start-ups have to be viable to make an impact and due diligence helps me invest in things that are viable,” she said.
Kraus was one of the speakers at a a seminar held Tuesday in Denver as part of the 6th Annual Angel Capital Summit, sponsored by Rockies Venture Club, a nonprofit organization that connects angel investors with promising entrepreneurial companies.
Kraus says she’s come full circle in her views on how much due diligence angels should perform.
“When I first started angel investing, someone told me that it’s more economical to take the time and money you’d spend on due diligence and invest small amounts into the companies that ‘feel right’ to buy an early seat at the table, then see how it goes,” she said. “But after learning some hard lessons, I no longer subscribe to that theory.”
Citing the findings of a November 2007 report from the Kauffman Foundation, the world's largest foundation devoted to entrepreneurship, Kraus said there’s a strong correlation between the amount of time angels spend on due diligence and the returns they realize.
Kraus says the transformation from her initial to current approach is the difference between “gambling and investing in something remarkable.” As an impact investor, she wants to put money into ventures that will promote positive social or environmental change.
Sheila Lamont, an attorney who works with Kraus and serves as director of deal flow and due diligence at Boulder-based Angel Support Network, suggests that investors plan to spend about 50 hours on due diligence for each company of interest, spread over a few months.