It’s difficult to be an expert in everything. Therefore, private market investors may come across investment opportunities that are outside their expertise or industry knowledge, especially in the case of innovative sectors like blockchain, next-generation battery tech, biotech, or aviation. How can investors properly conduct due diligence on an industry outside their expertise in order to make an informed investment decision? In this blog, learn more about evaluating deals outside your expertise, due diligence best practices, and making informed investment decisions.
Evaluating Deals Outside Your Expertise
Foundational Industry Knowledge
One of the first steps of evaluating deals outside your expertise is gaining a base level knowledge of the industry. Investors may want to identify the industry’s fundamental characteristics, economic drivers, and its competitive dynamics. Taking a look at an industry’s key players, emerging competitors, regulatory bodies, and main suppliers and distributors can help provide insight into how the industry works as a whole. Investors can also create a competitor analysis map to understand where the startup intends to position itself and where most competitors are focused.
Macroeconomic and Regulatory Drivers
Investors may also want to understand the external forces that are shaping the industry. Use independent market research reports to verify growth projections and the underlying assumptions. What legislation may be impacting the startup through regulatory bodies? How stringent does the startup need to be with compliance guidelines?
Product/Service Deep Dive
Investors may also want to gain a deeper understanding of the startup’s product or service. Some examples of information investors may want to request include technical architecture diagrams, core innovation information, or even seeking out a third-party technical consultant in order to provide an unbiased assessment of the technology. What part of the technology is proprietary? Is it a unique process, exclusive patent, or a more efficient business model?
Business Model Analysis
Understanding the startup’s unit economics and how the startup plans to make money is a central part of due diligence that can transcend industry boundaries. Is the startup seeking business to business or business to consumer channels? Is it a subscription or a one-time cost? What are the potential upsells and ongoing fees? How much does it cost for the startup to acquire each additional customer? What’s the path to growth?
Founding Team Evaluating
Especially in a nascent industry, investors may want to know why the founders/founding team is well equipped to be involved in the startup. Do they have prior industry experience? Do they have experience pivoting, failing, or even succeeding? If the founder has strong experience in leading people, do they have the team with the technical know-how even if the founder themselves does not?
Leveraging External Resources
While conducting due diligence on unfamiliar industries can be overwhelming, investors have many resources that can help them make informed investment decisions. In fact, leveraging external resources like professionals and experts can be an integral part of the due diligence process.
Investors can seek out experts in the industry for consultations on market trends, technological feasibility, and competitive dynamics. Financial news resources like PitchBook and Crunchbase may have industry trends, studies, and data points that can help with research. And investors should not be afraid to seek out financial professionals to help make investment decisions.
Final Thoughts
Making investments outside an investor’s core competency can seem daunting, but there are many ways that investors can conduct due diligence on these startups and some understanding to make an informed investment decision. By assessing the metrics that transcend industries, gaining a base level knowledge of the industry, and seeking out third-party professionals to fill in the gaps, investors can help themselves research opportunities.
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Want to learn more about investing in startups? Check out the following MicroVentures blogs to learn more:
- Subsequent Funding Rounds: Follow On Investments
- Understanding Tender Offers
- Understanding Valuation Caps
- Calculating a Startup’s True Runway
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
