If you’re looking for a way to shortcut your due diligence process…
Here’s a sneaky secret for rapidly screening deals to find ones that fit your investment policy statement (which you can create for free by going here).
Look for “Red Flags” and “Green Flags”
Here’s what I mean…
As investors, we need to constantly be looking at new deals. Professional investors (like venture capitalists) will look at 1,000+ deals per year only to pick 10-20 to invest in.
Broadly speaking, your deal flow pipeline will have three stages…
- Sourcing – Where does your deal flow originate (and what quantity/quality is it)?
- Selecting – What criteria do you use when considering an investment?
- Supporting – What actions will you take to help the investment grow (i.e. the Customer/Shareholder Flywheel)
But if you’re not a professional investor who has access to the very best deal flow, a fleet of analysts, and years of insider knowledge…
You need to take some shortcuts to help you manage your deal flow.
In the Sourcing stage, you need to look for reasons to say no.
A high percentage of deals you look at aren’t going to cross your minimum requirements for any number of reasons. We want to spot those deals killing “Red Flags” as soon as possible.
However, once we get into the Selecting phase, we now need to look for reasons to say yes.
The main due diligence framework we use is something called “The 7 Power Laws” – which helps investors identify where the company has the biggest opportunities to drive growth…
But before you need to start digging into some deep due diligence, there are some standard “Green Flags” you’ll want to look for, like…
- Large Total Addressable Market – a must-have for any “moonshot” investment opportunity.
- Revenue – While it’s not the end all be all, revenue gives an indication of product-market fit and the general unit economics of the business.
But another thing that’s important to look for?
- Insider Buying – How much money have the founders, friends, and family put into the deal already? And how much are they putting into this round?
This is important for a few reasons…
First, we like seeing founders who have “skin in the game.”
There’s been several studies that examine the impact this has on fund manager performance.
Empirical findings from other asset management settings, notably mutual funds and hedge funds, suggest that increasing a managerial ownership stake can enhance a manager’s bonding to the fund.
As the Financial Times put it, “capital commitment by fund managers is the single most important way to align the interests of managers and investors.”
While the studies cited are specific to the mutual fund and hedge fund sector, the logic is easy to understand…
When people have skin in the game, they have more incentive to manage resources and statistically speaking, they deliver better returns.
And one of the best signs of “skin in the game” is how much money the founders have put into the deal… and how much they’ve taken from friends and family.
Even better? How much are those same “insiders” buying in this current round you’re investing in?
Because there is such a large information gap in private markets, we often have to take cues from other insiders who have knowledge we don’t.
And while the average retail investor might not be able to get access to those insiders and interview them…
Seeing investment activity from insiders is a bullish indicator and a “Green Flag” we’re always looking for when considering deals here at Equifund.
And in case you’re wondering…
Equifund Crowd Funding Portal Get’s “Skin In The Game” Too, Aligning Incentives
Let me explain…
When we first set out to build the Equifund Crowd Funding Portal, we knew we wanted to be an “Investor First” platform.
Why? Because everyone else was talking about being a “Founder First” platform.
While there’s certainly nothing wrong with being a founder-focused platform, we believe it creates misalignment with investors.
If the benchmark for success is merely capital raised for founders – but not return on capital for investors – it means the portal has an incentive to structure returns based on fees, not performance, and list as many deals as possible.
According to a 2017 study released by NYU and Columbia University…
“When funds rely on outside capital, managers are compensated primarily from managerial fees and leave little value to outside investors.”
Put another way, when the management team is making all their money up front on fees… but nothing on the performance of the investment… there’s no real incentive for quality control.
In the short term, those companies may do quite well. In the long term, they risk serious reputational damage to their ecosystem.
That’s why we’ve chosen to take a large portion of our compensation as equity in every deal listed on our portal.
This means we treat every single Reg-CF issuer like a portfolio company!
It incentivizes us to negotiate better, “Investor Friendly” deal terms on our offerings… because those are the same terms we’re getting.
At the end of the day, we’re in this together. As shareholders alongside you.
Yours for investing equality,
Jordan Gillissie – CEO