Lamont also said it’s crucial for potential investors to get to know the company and the entrepreneur, as well as his or her other investors. In one case, Lamont found the company’s documentation looked great. “But the entrepreneur’s lead investor and majority owner was in the middle of a divorce and his assets were frozen,” she said. That could have severely limited the entrepreneur’s ability to raise follow-on capital from the lead investor, as planned.
Joni Kripal, an angel investor with a focus on emerging businesses in the health care industry, said she asks entrepreneurs if they’ve talked to thought leaders in their space and if they’ve looked at the competitive landscape. “Their responses often give me clues as to where I want to dig in later,” she said.
Kripal said it’s essential to read the fine print. One of the most significant items she overlooked on due diligence was a footnote at the bottom of a capitalization table showing the shareholders and their pro-rata ownership of the securities issued by a company she was evaluating. While most cap tables display ownership stakes on a fully diluted basis, allowing potential investors to determine a business’s overall capital structure at a glance, the footnote indicated that the table was not fully diluted. She had to do some math.
Once in a while, due diligence actually uncovers positive information about a company.
Lauren Costantini, vice president for therapeutic and device development at the Colorado Institute for Drug, Device and Diagnostic Development, invests in emerging life science and medical technology companies. She once evaluated a start-up whose medical device would have taken at least five years to get through the rigorous U.S. Food and Drug Administration approval process.
While performing due diligence, Costantini discovered that the product had an immediate non-medical, consumer application that could allow it to bypass the FDA route. “It could produce revenue in six months versus five years,” she said.