While we live in the times of Tinder and Bumble, the romantic notion of a dating period remains evergreen. Everyone cleans up well to make the first date perfect, with baggage packed and dumped in the storeroom. But however good the prospect seems; we are highly unlikely to pop the question at the end of the first date. Despite falling in love at first sight, it takes many seasons of trust building, alignment of long term goals, and stability before we are ready to take a leap of faith and tie the knot for the current, or all our seven lives.

We subscribe to the same thought process when we look at a funder-founder relationship. Sometimes we do fall in love with promoters at the first sight. But rarely do we want the butterflies of our first meeting to set the tone for a longer-term commitment. And hence we like to date them for a while before we say, “I do”. Since the word dating does not sound professional enough for board decks and strategy presentations, we call it ‘Due Diligence’.

The Tinder effect

While we subscribe to a more traditional thought process, the industry has become more modern. We can argue that lower interest rates, increasing risk appetites and mediocre return possibilities in other asset classes are pushing more capital towards ventures; and venture funds, flush with capital, are attacking opportunities with a never seen before gusto. When Tiger Global swipes right on 1.3 deals a day, is there even an argument left?

The episode of Cozo Pets is in fresh memory, where angels and micro VCs may not have checked for customers, scrutinized financials for legitimacy of cash flows and related party transactions.

The typical due diligence period at Malpani Ventures lasts approximately 6 weeks before we develop the conviction to issue a term sheet. During this 6-week period, we like to understand the business model, go over past, current, and future financials, talk to customers, understand longer-term strategy for the firm, evaluate founding team and second level management team, build our own projections after understanding the entire business, and make a recommendation to the investment committee, before we give the go-ahead to a funding request. Our term sheet is also contingent on clearing a financial and legal due diligence from an independent third-party vendor.

At times, we drop some deals in the middle of the process because we can not see ourselves as longer-term partners. And at times, we double our commitment and lead the round because of strong conviction.

While it may appear to a set of founders or investors that we are playing a cat-and-mouse game, or taking advantage of the fact that the ones who have capital make others dance to their tunes, veterans of the industry will appreciate that a detailed due diligence is in everyone's best interests. The more time incoming investors spend to understand the business before funding, the sooner the conviction builds, and quicker the cash gets in the bank. We have seen dying rounds oversubscribed due to the conviction of a certain investor who had done their homework with the founder.

While Malpani Ventures invests directly, our family office also invests in external managers as a limited partner. We see managers signing deals after the first meeting and wiring funds in 24 hours. We see a 2-day turnaround time on seed fund requests. We also see funds with weekly new funding announcements state that their investment thesis has no FOMO element. And this makes us wonder what we are missing in the game?

Join the herd?

Just as we encourage startups to experiment, we decided to walk our talk and experimented with a faster turnaround time on funding requests that already have a lead investor. We were ready to move in with a 1-week time horizon to quickly close the round. Everything went as per timelines, until it didn’t. And we received news that the founder reneged on signed terms with the lead. Ultimately, the lead folded and agreed to renewed terms since the company was in a fast-growing, hot sector, but we dropped out. Now, we do not have that much of a FOMO to go ahead with deals with a question mark on integrity.

Upon sharing this episode with counterparts over coffee, we were told to prioritize opportunity over integrity. But is it worth choosing opportunity over integrity? We have had a fair share of learnings to trust our original process.

We issued a term sheet and flew to another city to meet founders of an EdTech company only for the founders to turn up a few hours late, due to a night out the previous night. We later ended up withdrawing the term sheet over concerns on treatment of minority investors. A few months later we found the founders in a controversy not handled well.

We offered young and talented founders of a SAAS company the exact terms they wanted, only for the founders to drag their feet for 72 hours and revert with fresh terms. We still wonder what changed for their business during the 4-week period of due diligence for them to want completely different terms. We do not play these games and ended up withdrawing our offer. If you can play games after getting what you want, what do you have up your sleeve when you don’t get your way?

We were once close to taking up the entire round of a company to provide them a minimum 2-year runway and a head start against competition. But founders changed their funding ask no less than 3 times during the diligence period with completely different business plans every time. A promising 6-week diligence period ended with an email with specific explanations for passing that the founders did not even bother to reply to. Bad news is better than no news, eh?

We once found that founders of a startup were disbarred from holding director positions due to shenanigans elsewhere. Not only was this not disclosed, but the founders also came up with frail excuses whenever we asked why they were not directors in the company they fully own.

We also found once that the longer-term plan of a startup founder was to induct his son into the founding team. The son had no prior experience in the sector and the business was most likely to be run as a family business. We all know what happens to minority shareholders in a family business.

Baptism by fire

In hindsight, if we failed to conduct our typical diligence, we may have failed to unearth many of the above anomalies, until we were handcuffed in bed with the founders. We don’t perform diligence to conduct business-like excel gymnastics and ask random questions to satisfy our ego. We like to see diligence as a short period to build conviction on the founder's thought process, actions, and end goals.

These are just a handful of episodes that we can think about when people say quality outweighs risks. We do agree that quality outweighs risks, and as venture investors we recognize that even in a good decade for venture investing, 8 out of 10 bets will not work. But we hate for bets to not work because of non-business reasons. Our diligence period is to eliminate as many non-business failures as possible. We can live with business failures.

We do not know whether due diligence is passe, we will always hope integrity is not.