I was having a discussion with a friend who has moved from large cap PE to early stage VC (seed / series A) and he is concerned that his new firm has no material budget for diligence, whereas at his large cap firm, they had a seemingly bottomless purse for diligence.
The VC has no budget for surveys or interviews for commercial, which is of greater concern than financial because frankly the financial data doesn't exist in material form yet.
How do you suggest he adjusts?
Suggest he learns how VCs do deals and adapt - I.e. just flip a coin
Can you please elaborate on how you can develop conviction around an investment without PE-style diligence?
At seed diligence is more about team, market and core tech (if any) given there isn't usually anything to diligence.
In VC, the performance of your investment will rely on your ability to identify the right team and the right solution for the market, with very little for external providers to diligence (e.g. few tangible assets, few contracts, no meaningful financial track record). Most of the future value of the company is based on things that do not exist at the time of the first round of funding.
Commercial and strategical expertise will most likely be held in-house compared to a more traditional PE investor who might partially outsource BP/bid strategy to consultant/financial advisers. Your friend will probably be more heavily involved in day-to-day tracking of the business performance to make sure the company achieves the different "milestones" the fund has set at the time of the investment.
I mean just break down the components of PE DD and ask if they apply to VC investments.
Accounting DD? No. (at least not to the same extent)
Legal DD? Yes, but just being a younger company, there's less to diligence here.
QOE? lol they don't even pretend to have earnings
Plus keep in mind if he's doing early stage, he's probably investing six figures to a couple million per deal, so he has to be more mindful of deal expenses as a % of invested capital (Cravath doesn't reduce their rates/hour just because your deal is smaller). To some extent, you just have to be willing to stomach the risk, but the counterpoint is that your fund is spread over more investments so one going sour isn't as bad.
Yep. Nailed it. This is why accelerators/seed investors typically have a template agreement they'll stick you in. Take Y-Combinator for example, where it's low six figures a pop, then their goal is just to stick their hands in as many places as possible as fast as possible and hope a few do well. Who is going to spend (a min of) $40,000 on a QofE on a co doing like $1m - $4M in rev tops?
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