Catalyst Fund, a global accelerator that supports inclusive tech innovators and facilitates the growth of innovation ecosystems in emerging markets, has released a guide on how investors can effectively conduct remote due diligence on startups before investing. The guide which seeks to help investors assess startups, shares insights into three product areas that can support inclusive recovery and build.

What Does The Guide Recommend?

Broadly, the guide reviews critical areas to focus due diligence efforts on, and they include: team, product, market, financials.

On Team

The guide notes that many early-stage investors note they invest in innovators and leaders, and not in a product, as that product is likely to evolve significantly as the team works to achieve product-market fit.

“In some ways, the pandemic itself provided investors valuable information about a critical aspect of leadership: evidence of how the team reacts under pressure. Investors had a firsthand, realtime view into how teams handle changing circumstances — from new regulation to disrupted field operations to decreases in user purchasing power. Some told us that surviving the pandemic itself was an extremely strong signal of leadership resilience and resourcefulness,” the guide notes.

Recommendations On Team

On team, the guide makes the following recommendations:

• Observe team dynamics during video calls — the guide exerts investors to note how team members interact with each other, the level of control the CEO has, whether teams have clear areas of responsibility, and whether the CEO delegates questions to them appropriately.

• Vary the format and tone of video calls — The guide advises investors to interact with the founders in different environments and learn more about them, try to vary the format of conversations. The rapidfire Question & Answer session at the end of the pitch gives them insights into how the founders perform under pressure.

• Probe leadership capabilities in hard times — On this, the guide notes questions such as “How is your team responding to COVID19 + adjusting plans?” may help. “This question gives investors insights into the challenges the team is facing and how leadership is tackling them,” it states.

• Psychometric evaluations — The guide also recommends that investors may use this approach to learn more about the founders’ personalities and behavioral aptitude, although it notes that such tests have their flaws (e.g., cultural bias).

• Diversified and deeper reference sources — The report also recommends that investors can complement direct observations. For example, it notes that Angel Ventures, reaches out to startup team members who are not directly linked with the fundraising process to learn about the work environment and how the team works together.

Recommendations On Product

In addition to typical data analysis, the guide notes that many investors said they tried (or asked local partners to try) the startup’s services (and those of their competitors), since anonymity was much easier to maintain.

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“With regards to product assessment, the pandemic again offered investors some advantages. Since field operations were suspended, startups had to pivot to pure digital plays, making it easier for investors to experience, observe, and stress-test operations from afar,” it states.

Therefore on product, the guide makes the following recommendations:

• Go mystery shopping — the report advises investors to pretend to be a target customer and reaching out to the company with queries about the product and how it works. Additionally, it advises them to shop at the startup’s competitors to see if the service and experience is distinctive.

• Become a customer — the report also exerts investors to download and use the startup’s product or a prototype. It says it helps to stay long enough to experience product updates and marketing campaigns. Look out for bugs, report them as a customer, and evaluate the overall user experience, it says.

• Conduct virtual site visits — the report further counsels investors to observe startup operations through video calls or recordings, where possible.

• Listen to customers’ opinions — by identifying the top customers and scheduling calls with them to learn more about their experiences with the startup, it says. It further recommends that investors read app reviews, and talk to businesses from your or your partner networks that could be potential users to hear their views on the startup’s value proposition and growth potential.

• Take a data-heavy approach — Finally on product, it advises investors to ask about customer acquisition rates and costs. It also exerts them to closely interrogate the data as this can be invaluable. The ideal approach is to get direct access to the startup’s database to analyze basic metrics like acquisition costs, retention rate, lifetime value, average revenue per user, and other metrics related to sustainable growth, it says.

Recommendations On Market

The guide recommends the use of triangulate information with multiple sources to get a more accurate and comprehensive map of the startup’s market. Traditionally, investors triangulate information more with specific stakeholders in their networks, leaning on personal or informal networks, it says.

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Particularly, the report notes that in the remote environment, the sources investors are tapping have expanded to include:

• Accelerators/incubators — that can derisk high-potential startups and provide tailored insights, especially if they have a local presence and sectoral expertise.

• Data-based benchmarks — that can situate models or sectors in relation to each other.

• Third-party references and experts — within local networks that could provide direct insights, or connections to other founders that can offer their market experience.

Recommendations On Financials

Perhaps unsurprisingly, the guide notes that financial analysis due diligence has remained largely intact, since very little was dependent on in-person interactions in this space previously.

“However, we did hear that investors expected startups to be leaner and that investment decisions were more focused on unit economics and profitability than before. For instance, they noted that healthy unit economics were weighted more heavily in recent investment decisions,” the guide notes.

Therefore on financials, the guide makes the following recommendations:

• Apply a deeper focus on select financial metrics — the guide suggests that investors should take a closer look at unit economics and business model intricacies, with a greater focus on CAC, retention rates, and profitability. It also enjoins them to consider performing scenario analyses on all possible revenue models. Also, take a stricter look at a startup’s total runway and burn rate, and focus on the team’s ability to stretch money for a longer period of time, it notes.

• Look for a lean execution team — the guide recommends that investors examine team salaries and how roles at various levels are compensated. Review team utilization with managers and leadership to assess any redundancies in roles, and also review long-term staffing needs and hiring plans, it states.

For other more detailed recommendations, download the guide here.

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Charles Rapulu Udoh

Charles Rapulu Udoh is a Lagos-based lawyer who has advised startups across Africa on issues such as startup funding (Venture Capital, Debt financing, private equity, angel investing etc), taxation, strategies, etc. He also has special focus on the protection of business or brands’ intellectual property rights ( such as trademark, patent or design) across Africa and other foreign jurisdictions.
He is well versed on issues of ESG (sustainability), media and entertainment law, corporate finance and governance.
He is also an award-winning writer