🕵️Due Diligence Math

Review 3,225 startup applications per year to get a chance at the unicorn opportunity

The first week at the VC Lab Venture Institute gave me two key insights (detailed post):

1. Seek opportunities for 10-100x returns, rather than just investing in any new tech business that can earn a profit or be acquired with at least 2x returns.

2. 1% of startups in deal flow get funded, which requires reviewing 1000 applications to make 10 investments per year.

We all know that 90% of startups fail. Last week, 60x angel investor and LP Rem Darbinyan at STAN's webinar added an extra 6.9% which becomes self-sustaining business not giving the returns VCs need to cover failures. So basically, 3.1% of the 1% of invested startups outperform.

Startup Statistics: data by Rem Darbinyan, chart by Alex Samson.

This means a VC has to review 3225 startup applications per year to get a chance.

I don't add here that only 10% of applications come from cold outreach, meaning that a VC has to have a strong and warm deal flow of 3225 or multiply it with cold applications.

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Let's omit from today's math the time required for screening and scoring deal flow to get 10% picked for due diligence (DD).

One investment requires 10 DDs. To get one outlier startup in the portfolio per year, a VC has to conduct DD on 323 startups per year, or 6 startups per week without vacations.

With my tech and new market due diligence, which takes one intensive week, I will need six years to invest in a super opportunity.

How can emerging VCs address the due diligence swamp?

Or how to explain the DD strategy to an LP who can do the math.

No way:

1. 🦮 Don't do due diligence, blindly follow top-tier VCs: Not much sense for LPs to invest in an emerging VC rather than directly in a top-tier VC.

2. 🎸 Get together with 6 active GPs: An option, but management risks with such a boys/girl band founding team size.

3. 🧐 Hire 6 analysts: Let's take a $120K annual salary per each, which means $720K per team. With a 2% management fee, this requires $36M for Fund 1 capital only on the DD team. Not feasible.

4. 🕴️Outsource: Same cost as a team of 6 plus a consulting profit margin. Not feasible.

Art of Combinations:

• 🏭 Specialize in an industry/market to have metrics and access (post)

• 🗓️ Do DD week by week to increase productivity.

• 🤝 Have a team with a few GPs, VPs, and associates.

• 🐢 Reduce expectations to have 1 outlier startup every 2 or 3 years.

• 🦮 Follow top-tier VCs sometimes.