In a world brimming with innovative ideas and groundbreaking startups, investors must navigate the terrain with a keen eye and a robust toolkit. Due diligence is the cornerstone of informed investment decisions, serving as your compass through the exciting yet unpredictable landscape of equity crowdfunding.

Crowdfund investing through Reg CF and Reg A presents unique opportunities and challenges. Unlike traditional investment avenues, it opens the doors for retail investors to play a pivotal role in the startup ecosystem, contributing to the growth of companies that could shape the future of technology, services, and societal norms. However, the risk associated with early-stage investing is considerable. The startups you invest in are often untested in the market, and their success hinges on a myriad of factors, from the vision and resilience of the founding team to the viability and scalability of the product.

In this guide, we will dig into the essence of due diligence, demystifying the process and arming you with the tools and frameworks that have steered seasoned investors toward success. We draw upon my 5 Ts framework—Team, Technology/Product, Total Addressable Market (TAM), Traction, and Terms—to provide a structured approach to evaluating potential investments.

Whether new to crowdfund investing or looking to level up your strategies, this guide will enhance your understanding, expand your capabilities, and elevate your investment approach on platforms like KingsCrowd.

In this complete guide to due diligence for crowdfunding investors, we’ll cover:

Section I: The Essentials of Due Diligence

The Bedrock of Investment Wisdom

In early-stage investing, due diligence is the systematic approach to assess a startup’s viability, risks, and growth potential. It is akin to a comprehensive health check-up of a company before committing your funds. By delving into the company’s business model, market potential, financial health, legal standing, and the team’s capability, due diligence equips investors with a clearer picture, reducing the likelihood of unpleasant surprises down the line.

The Importance of Due Diligence

Due diligence is critical because it correlates directly with investment success (see below figure). Startups are complex entities where multiple dimensions must align for success. Each aspect of a startup must work reliably, from its product to its market fit. If one fails, it can compromise the entire venture. And often, in the early stage, one of the most important factors is the quality of the founders and founding team.

Time as an Investment in Itself

The time spent on due diligence is an investment that can dictate the returns. Evidence suggests that investments backed by substantial due diligence have historically yielded higher returns. A 2007 study by Wiltbank and Boeker highlighted that angel investors who spent over 20 hours on due diligence realized nearly six times the returns compared to those who spent less than 20 hours​​.

Chart showing correlation of time spent doing due diligence vs. investment returns

From 2007 study, “Returns to Angel Investors in Groups”. Wiltbank and Boeker.

However, smaller crowdfunding investors may not be able to spend 20-40+ hours per deal, especially considering that the average Reg CF investment size is under $1000 per investment.

How can crowdfunding investors leverage their time so that they don’t have to spend 20-40+ hours per deal but can still make informed investment decisions? That is where platforms like KingsCrowd can offer ratings, analyst reports, interviews with founders, and more resources to help crowdfunding investors make the most efficient use of their time.

In the next section, we’ll dive into one simple framework for analyzing startups—the 5 Ts of crowdfund investing—providing you with a structured way to screen your potential investments.

Section II: Framework for Analyzing Startups

Introducing the 5 Ts of Crowdfund Investing

The 5Ts framework for assessing crowdfunding deals

A structured approach is indispensable when navigating the complexities of startup investments. My 5 Ts framework—Team, Technology/Product, Total Addressable Market (TAM), Traction, and Terms—provides a comprehensive lens through which to examine each investment opportunity.

  • Team: The driving force behind any startup is its founding team. Their expertise, adaptability, and vision are paramount as they conceive and bring the product to market. It’s crucial to assess whether the team possesses the necessary skills, experience, and determination to overcome obstacles.
  • Technology/Product: A startup’s product or service should offer a novel solution to a significant problem. It’s essential to evaluate the product’s uniqueness, development stage, and capacity to satisfy the market’s needs.
  • Total Addressable Market (TAM): The best product is only as good as the market it serves. Assessing TAM involves understanding the market size, growth potential, and the startup’s strategy to capture a share of this market.
  • Traction and Financial Viability: Traction demonstrates a startup’s progress and potential for success. Indicators such as sales figures, user growth, and strategic partnerships are tangible evidence of market demand and operational execution.
  • Terms: The investment terms should align with your goals as an investor. This includes the valuation, equity offered, the founder’s ultimate vision, and exit strategies.

While KingsCrowd’s five areas of ratings may go by slightly different names, you can see how each of my “5 Ts” maps to a KingsCrowd rating:

  • Team –> Team
  • Tech –> Differentiators
  • TAM –> Market
  • Traction –> Performance
  • Terms –> Price

Critical Questions for Each Area

Each ‘T’ of the framework invites specific questions that guide the due diligence process, ensuring no stone is left unturned.

  • Team: Does the team have a track record of success, or do they possess unique insights into the industry they’re disrupting? Do they want to win against all odds?
  • Technology/Product: Is the technology at least 10X better than anything available on the market, and is it solving a real problem (that customers are willing to pay for)?
  • Total Addressable Market (TAM): Is the market large enough to support substantial growth, and is it accessible?
  • Traction and Financial Viability: What milestones has the company achieved, and what is the growth trajectory?
  • Terms: Are the investment terms fair, and do they provide the potential for a satisfactory return on investment?

Having dissected the 5 Ts framework, our next segment will delve into practical steps investors can take to apply it in their due diligence process, utilizing available resources to make informed decisions.

Section III: Practical Steps for Investors

Conducting Due Diligence

Once familiar with the 5 Ts framework, investors need a clear path to apply it effectively. Here’s a step-by-step approach to due diligence:

  1. Initiate Contact: Begin by engaging with the startup through available channels—webinars, Q&A threads on funding platforms, and on company’s websites or communities.
  2. Gather Information: Use funding portals, investor networks, tools like KingsCrowd, and public databases to collect data. Review SEC filings for legal and financial insights.
  3. Analyze the Data: Compare the startup against industry benchmarks and competitors. Validate claims and projections against market research.
  4. Consult the Checklist: Reference our free crowdfunding investor due diligence checklist to ensure no critical element is overlooked​​​​.
  5. Seek Peer Insights: Participate in investor forums and discussions to gauge collective sentiment and gather diverse perspectives.

Leveraging Due Diligence Resources

Equity crowdfunding investors have access to a wealth of resources:

  • Investor Education: Platforms like KingsCrowd offer educational materials and insights specific to crowdfund investing.
  • Funding Platform Data: Utilize the analytical tools and data provided by platforms like Wefunder, StartEngine, and Republic to assess startups.
  • Reg CF Platforms: These platforms must legally perform initial (albeit limited) due diligence checks on companies before listing them, including background checks on company directors, bad actor checks on the issuer and promoters, and reviewing company claims for obvious red flags and potential fraud. They serve as a first filter for investors and provide a structured format for company disclosures.
  • Professional Networks: Engage with industry experts and seasoned investors for mentorship and advice.
  • Online Resources: Research more online on sites such as LinkedIn (team), the company’s website and social accounts, and Crunchbase or Statista for additional insights.

In the next section, we’ll focus on the critical role of the startup’s founder and team, whose dedication and vision can often be the deciding factor between a startup’s success and failure.

Section IV: The Founder’s Role and Startup Team

Assessing Leadership and Team Dynamics

The founder and the team are the heart of a startup. Investors must evaluate the founder’s credentials and their passion, resilience, and commitment to the venture. The ‘never give up’ mindset is a key indicator of potential success, as many startups face numerous challenges and pivot points on their journey​.

Key Considerations for Team Evaluation

  • Experience and Expertise: Does the team have relevant industry experience and a clear understanding of the market they are entering?
  • Adaptability: How has the team responded to setbacks or pivots? Can they navigate the uncertainties inherent in the startup world?
  • Chemistry and Commitment: Is there a strong dynamic within the team? Do they exhibit a unified vision and a relentless drive to succeed?

The “Employee Question” to Assess a Founder or Team

There is one question I ask myself when assessing a team, which helps to boil down all the key components of whether a startup founder or team may be successful leads. The question is:

Would I want to work for this founder and with this team?

Granted, not every successful startup will be perfect from the start. However, many famous angel investors and venture capitalists believe that especially the first few hires are crucial to establishing the culture that the company will embody. And it’s no secret that hustlers and top talent will attract other top performers. So having A-players on the founding team is crucial.

Conclusion: Harnessing Due Diligence for Investment Success

In crowdfund investing, due diligence is not a mere formality—it’s an essential discipline that can significantly impact the success of your investment portfolio. By thoroughly understanding the importance of due diligence, applying the 5 Ts framework, taking practical steps, and evaluating the startup team, you equip yourself with a powerful approach to selecting promising startups.

Embrace due diligence as a continuous learning process that evolves with each investment. Utilize the tools and resources, and never underestimate the power of a committed founder and a cohesive team. Here at KingsCrowd, we stand ready to assist you in this exciting journey of discovery and investment.

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