Understanding Management Team Due Diligence
Due diligence is used to evaluate the potential and risk of a given investment. Peter Thiel, entrepreneur and venture capitalist, said, “Great companies do three things. First, they create value. Second, they are lasting or permanent in a meaningful way. Finally, they capture at least some of the value they create.” Investors look closely at all aspects of the company, including their management team, the market, and their technology. Let’s dive deeper into what investors look for in their management due diligence.
Management Team Diligence
“The reasonable man adapts himself to the world, the unreasonable one persists in trying to adapt the world to himself. Therefore, all progress depends on the unreasonable man.” – George Bernard Shaw, Maxims for Revolutionists, 1903
Subjectivity in conducting management team due diligence can often be crippling and unfortunately, is often the case. Attributes of strong management teams are difficult to assess and investors often have a short window of time. Below are a few key qualities investors look for in a management team.
“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.” – Warren Buffet, 2015
Integrity involves the a person’s honesty in words and actions. The process of assessing one’s integrity is especially difficult and imprecise, but often involves referencing – having discussions with people who have interacted with the entrepreneur in the past.
Another quality investors look for in a management team is their team building skills. Questions they will often ask are:
- Do they understand their own limitations and weaknesses?
- Are they able to attract a team?
- Is this person honest and bold enough to replace themselves at the right time and even become redundant?
These qualities are key for success, but are oftentimes hard to come by. Weak entrepreneurs gravitate towards looking smart in a land of the small instead of standing on the shoulders of giants.
Execution is simply the art of getting things done. CEOs that work hard, move quickly, act aggressively, set high standards, hold people accountable to them, and demonstrate persistence are qualities investors look for.
Serial Entrepreneurs vs. First-Timers
30% – A VC-backed entrepreneur who has taken a company public has a 30% chance of success in their next venture
20% – A failed entrepreneur has a 20% chance of success in their next venture
18% – A first-time entrepreneur has an 18% chance of success in their first venture
Despite an entrepreneur’s past experience with starting a company, a major cause of success for entrepreneurs is knowing how to launch companies at the right time before markets get crowded. Marketing timing skill is arguably more important than the novelty of the technology.
A study conducted by two MIT researchers, Sandy Pentland and Daniel Olguin, predicted who would win a business plan competition with 87% accuracy. They did so by gathering “honest signals” from executives.
Honest signals are nonverbal cues, consisting of gestures, expressions, and tone. I”The more successful people are energetic. They talk more, but they also listen more… It’s not just what they project that makes them charismatic; it’s what they elicit. The more of these energetic, positive people you put on a team, the better the team’s performance,” said Pentland in an interview with Harvard Business Review.
Does your management team have what it takes? Apply for Flow Capital.
Alex Pentland, “Defend Your Research: We Can Measure the Power of Charisma,” Harvard Business Review, January‐February 2010, accessed February 7, 2011, http://hbr.org/2010/01/defend‐your‐research‐we‐can‐ measure‐the‐power‐of‐charisma/ar/1.
Paul A. Gompers, Anna Kovner, Josh Lerner, and David Scharfstein, “Skill vs. Luck in Entrepreneurship and Venture Capital: Evidence from Serial Entrepreneurs,” July 2006. Available at SSRN: http://ssrn.com/ abstract=933932.
Ramsinghani, M. (2014). The Art of Conducting Due Diligence. In The Business of Venture Capital, M. Ramsinghani (Ed.). doi:10.1002/9781118931646.ch16