How Investors Without a Technical Background Can Complete Due Diligence on Technology Startups

For non-technical investors, it can be difficult to independently evaluate whether a heavily technical startup’s product is feasible, functional, or even real. However, an investor can do research such as gaining a basic understanding of the industry, asking questions, and conducting structured due diligence to help make an informed decision about technology startups. In this blog, learn more about conducting technical due diligence on startups as a non-technical investor and how to gain a basic understanding of more complex industries.

Technical Due Diligence for Non-Technical Investors

While private market investors won’t need to become an expert in every industry they plan to invest in, having a basic level of technical literacy in the industry is beneficial. It’s important for investors to research any unfamiliar opportunity they are considering—whether financial instrument, industry, revenue model, or type of company. There are risks with investing in unfamiliar industries, as seen through some recent examples.

Theranos

In the case of Theranos, product readiness and capabilities were misrepresented, and even missed by technical founders themselves. Elizabeth Holmes, currently serving an 11-year fraud sentence, made lofty promises to investors despite the product’s technical deficiencies. Theranos claimed to have developed a revolutionary device that could run hundreds of tests from a small blood sample. In reality, that technology was not feasible and didn’t function as Holmes represented. Many investors lacked the technical wherewithal to investigate those claims deeply or understand the challenges the technology faced. It all became evident in 2022 when the Northern District of California court ruled that Holmes knew the technology was non-functional but continued to de-fraud investors anyway.

Lily Robotics

A lesser-known case, Lily Robotics, was sued in 2017 over false advertising claims for its photography drone. Designed to use GPS tracking and visual recognition to follow a user without need for a remote, Lily produced a marketing video in 2015 for a crowdfunding campaign showing the drone’s capabilities. Except, the video actually featured camera shots filmed by a completely different drone camera: a DJI Inspire, an expensive competitor product that is remotely controlled, unlike Lily’s “competitive advantage”.

Lily’s cameras didn’t have all of the advertised features and according to an early technical employee, the colors were off and the shots were blurry. Lily sold $34 million in presales but kept delaying presale delivery until it was sued by the San Francisco District Attorney office and filed for bankruptcy. This could be considered an example of investors getting caught up in the potential “cool” factor without learning enough about the industry to question the reality and current capabilities of the product.

Generative AI Tools

As generative AI tools like ChatGPT for text, DALL-E for images, and Sora for video become more commonplace, the risk of potentially misleading marketing components is another risk for investors. Since these tools can fabricate product interfaces, simulations, or use cases, images and videos should be carefully considered and footnotes and disclosures carefully reviewed to help investors understand if the media is real or represents a future dream.

How to Conduct Research

With the risks of investing in a technical startup without being able to understand the technology or industry, how can investors conduct research during the due diligence process in order to make informed decisions?

Understand the Basics

First, investors should make an attempt to understand the basics of the industry. Where did the industry start? How have capabilities grown over the past few years? What are the current capabilities? What do industry experts say about future trends to watch and potential future capabilities? Does the startup’s current and future goals align with what a reasonable person could expect the next innovative breakthrough could be for this industry? By understanding where the rest of the industry is and where the startup currently claims to be and its future plans, these answers can help shape the rest of the diligence process. The goal of understanding the basics is not to master the industry, but gain the ability to ask informed questions about the product.

Ask Process-Oriented Questions

Next, investors may want to ask process-oriented questions to understand the steps the company plans to take to achieve its goals. What specific milestones must be achieved before the product can launch? Are there technical bottlenecks that exist? What external risk factors could delay timeline? What are the current challenges that are preventing the company from being further along in the process? These questions can make founders have to be specific about performance and outcomes, and potentially uncover deficiencies in future roadmap plans.

Request Evidence and Sourcing

Investors should always seek to have sourcing and evidence to back up claims that the startup makes. Are there patent filings behind the technology? Are there test reports that verify progress milestones? Is there proof that this technology is actually obtainable under current circumstances? Being able to verify claims with sourcing and evidence can help verify that a technology is not just plausible, but also possible.

Engage Independent Experts

In the case of highly technical industries where the previous information is difficult to obtain, or is even still too technical to be completely understood, investors may want to seek out and engage independent experts in the field. These experts, especially if they are not associated with the startup, can help an investor understand the startup’s goals and industry capabilities, and provide insight into the reality of the technology. By leveraging other expertise and insight into a highly technical industry, investors may be able to glean more information than attempting to do the research themselves, especially since they are able to ask questions to someone that doesn’t have a vested interest in the startup.

Final Thoughts

With the risks of making investments in industries that an investor doesn’t fully understand themselves, there are still ways for non-technical investors to research opportunities in technology-heavy industries. By gaining a basic understanding of the industry, asking process-oriented questions, and requesting evidence and sourcing, investors can gain a deeper understanding of a tech-forward product or service. Furthermore, engaging independent experts can help fill in the gaps and provide additional context for deeper understanding.

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Want to learn more about investing in startups? Check out the following MicroVentures blogs to learn more:

• What to Look for in Investment Updates
• Early-Stage and Late-Stage Companies
• Assessing Customer Retention Metrics
• The Growth of Supply Chain and Logistics Tech

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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.