In the pre-seed stage of startup funding, due diligence performed by venture capital (VC) firms is typically less intensive compared to later stages, as startups at this point are in the early stages of development. However, VCs still need to assess potential risks and opportunities, ensuring that the idea, team, and market have the potential to grow into a viable business.
Here’s a detailed breakdown of what due diligence looks like during this early stage:
Pre-Seed Stage Due Diligence
Focus: At the pre-seed stage, VCs focus more on the founding team, the idea, and the potential for market disruption. The product may still be in the concept or development stage, so financials and traction are usually minimal.
Key Areas of Due Diligence:
Founders & Team:
Background Check: VCs pay close attention to the background of the founders—professional experience, educational qualifications, past entrepreneurial ventures, and their ability to execute the idea.
Team Dynamics: They evaluate how well the founding team works together, their commitment to the venture, and how they handle adversity.
References: Speaking with past employers, colleagues, or investors to understand the founder’s strengths and weaknesses.
Idea & Vision:
Problem-Solution Fit: VCs assess whether the startup is addressing a real and significant problem in the market and if their solution is unique or innovative.
Vision: The long-term vision of the founders is important—whether they are thinking big and aiming to build a scalable business.
Market Potential:
Market Size: Analysis of the total addressable market (TAM) to ensure there is enough room for the startup to grow.
Competition: A preliminary look at competitors to understand if the startup has a competitive edge or can carve out a niche.
Product & Technology (if applicable):
Feasibility: If there is an early-stage product (MVP), VCs will evaluate its feasibility and whether it can be built or scaled as envisioned.
Technology Stack: A quick assessment of the technology being used or planned, including whether the team has the capability to develop and execute on the technical aspects.
Business Model:
Revenue Model: Even if there are no revenues yet, VCs will look at the proposed business model and assess whether it is scalable and profitable over time.
Unit Economics: High-level consideration of how the business could make money (e.g., pricing models, cost structures, customer acquisition channels).
Initial Traction:
Proof of Concept: If available, VCs will evaluate early product prototypes, pilot results, or user feedback to gauge potential customer interest.
Early Validation: For some startups, especially in SaaS or tech sectors, initial beta users, partnerships, or collaborations may act as validation points.
Legal & Corporate Structure:
Company Incorporation: Review of incorporation documents, founder agreements, and share distribution. It's important for the VC to know that the business has been set up legally and appropriately.
Cap Table: A check to ensure that the equity ownership of the company is clear and well-structured, without excessive dilution from early investors or advisors.
IP & Trademarks: If applicable, VCs will look for patents, trademarks, or copyrights to ensure that the startup owns the intellectual property it's building upon.
Since this stage is early in the startup life-cycle, there is more risk involved, but VCs are typically willing to make investments based on potential rather than hard financial data.