Welcome back to Deep Tech Catalyst, the channel where science meets venture!
In today's episode, we're thrilled to welcome Moien Giashi, Principal GreenSky Ventures, from Toronto, Canada.
What started as an overview of due diligence in early-stage Deep Tech quickly evolved into a blend of inspiration for entrepreneurs and an educational lesson on the operational workings of a VC fund.
This is invaluable for anyone in the scientific community who aspires to launch a Deep Tech startup and is facing the challenge of approaching a venture capital fund for the first time!
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💡 What is a VC Fund and How Does It Work?
Historically, various institutions pondered over how to best utilize the funds they amassed. They recognized the necessity of investing those funds. This led to the emergence of different investment categories and vehicles.
For instance, some might opt to invest their capital in real estate, purchasing homes or properties. Others could be drawn to larger-scale projects such as infrastructure development, involving the construction of bridges or dams. Moreover, there's the option to acquire ownership in well-established corporations, which falls under the domain of private equity.
On the opposite end of the spectrum, we find higher-risk investments.
These entail investors putting their money into early-stage companies, which inherently carry a high risk, both in terms of technology and market viability. The goal here is to maximize returns as the company grows, ultimately delivering substantial gains to the investor. This distinctive category is what we call venture capital.
It's an asset class renowned for its high-risk, high-reward nature. Typically, only a small portion of pension or endowment funds is allocated to venture capital as an asset class. It's characterized by a power-law return distribution, meaning that while many investments may yield no returns, a select few can significantly outperform, greatly benefiting the fund overall.
What's essential to understand is that venture capital represents just one avenue of investment. However, it plays a pivotal role in the innovation ecosystem by championing research from laboratories and facilitating its journey to the market, ultimately enabling commercialization.
⚙️ How Does a VC Fund Work?
The structure of a venture capital firm comprises two critical player groups:
Limited Partners (LPs);
Fund Managers or General Partners (GPs).
LPs are external investors who infuse capital into the venture capital fund, while GPs hold the responsibility of managing and overseeing these funds. An intricate relationship exists between LPs and GPs, grounded in performance metrics.
If the fund outperforms expectations, both GPs and LPs reap the benefits. Content LPs are more inclined to reinvest or increase their investments when they witness exemplary performance. Therefore, the entire venture capital landscape revolves around performance, ensuring that the fund's multiple is robust and that capital returns as planned.
Moreover, trust and confidence between LPs and GPs are pivotal aspects of this relationship. LPs must have faith that GPs are diligently conducting their due diligence. They want assurance that GPs are actively researching and comprehending the technology and opportunities they invest in. Sometimes, LPs may even request to review the due diligence reports prepared by GPs, seeking insights into why specific investment decisions were made. This not only serves as a legal necessity but also functions as a tool for GPs to justify their investment choices.
In essence, due diligence is the crux of the matter. It's the process through which a venture capital firm makes informed investment decisions. It takes the form of a comprehensive document or research effort that equips the investor with an in-depth understanding of the company under scrutiny.
🔍 Deep Tech Due Diligence 101
Due diligence spans multiple dimensions, encompassing technology, business, and legal aspects.
Technology
In the realm of technology, during the due diligence process, the primary objective is to grasp the intricacies of the technology itself. For instance, in the case of a software solution, one would delve into the underlying architecture. If it's hardware, the architecture of the hardware would be examined.
Fundamental questions include understanding the hardware components or software framework. Additionally, the due diligence explores advanced materials and any unique attributes associated with them.
Intellectual property (IP) is another focal point; this entails determining whether patents or trade secrets are in place, as these can set a venture apart.
Feedback From Customers
Furthermore, it's essential to assess how well the technology functions and gather external perspectives. This might involve seeking feedback from customers or individuals outside the company to gain insights into their experiences and perceptions of the technology.
This rigorous examination serves several purposes.
First, it helps identify the intrinsic value of the technology itself. In the worst-case scenario, if all else fails, is the technology itself valuable enough to stand alone or potentially be sold to another entity?
Second, it ensures that the venture capital firm comprehends the technology thoroughly, enabling it to provide meaningful assistance to the company in the future.
Lastly, it confirms that the technology is tangible and genuine, eliminating any doubts about its existence or viability.
Business Model
Moving on to the business aspect of due diligence, the objective is to gain a comprehensive understanding of the company's operations. This includes identifying the target customer base, evaluating customer satisfaction, and assessing the chosen business model. The level of scrutiny can vary based on the company's stage of development. For early-stage companies lacking customers, the assessment may not delve as deeply, but the fundamental questions remain relevant.
Due diligence serves as a signaling mechanism for entrepreneurs. It underscores the critical elements that will be vital to their success—knowing your customers, understanding their perspective on your product or business, and selecting the appropriate business model.
It's not uncommon for startups to initially adopt a subscription-based model, only to discover that their industry prefers one-time payments. This revelation prompts a pivot in their business strategy.
To recap
In summary, due diligence is a multifaceted process that provides a comprehensive understanding of the technology, business, and legal aspects of a company. It equips investors with the knowledge required to make informed decisions, ensuring that they are well-prepared to navigate the complex landscape of venture capital investments.
👥 Team > Technology
When it comes to due diligence, one of the primary focal points for us is the team. It holds immense importance in our assessment. Understanding who comprises the team and how they collaborate is a nuanced process that goes beyond just reviewing documents or reading through profiles. It involves direct interactions with the entrepreneurs, co-founding members, and the team as a whole. We engage in conversations, pose questions, and keenly observe how they respond, especially when confronted with challenges or inquiries.
In this journey of exploration, we also reach out to individuals who may work closely with the team, such as employees or interns. Their insights are invaluable for gaining a holistic understanding of how the team operates, manages, and leads. Likewise, we often extend our inquiries to customers, probing into their experiences with the team. We aim to uncover facets like responsiveness, customer service quality, and the overall perception of the team's competence.
Additionally, many of the companies we engage with have advisors or board members. Their perspectives provide a valuable layer of insight. By interviewing these individuals, we gain a more comprehensive view of who is steering the ship, what their behavior and interactions are like, and what they bring to the table.
🟢 Green Flags
The green flags in this context usually manifest when the team demonstrates seamless collaboration, free from internal conflicts or rivalries. Positivity and a shared vision among team members are favorable indicators. When we receive feedback from customers emphasizing the team's responsiveness and the quality of their customer service, it's a positive signal. Similarly, when interns or staff members express satisfaction with leadership and highlight support for their professional growth, it underscores the team's effectiveness.
🔴 Red Flags
On the flip side, red flags may emerge if we encounter instances where the CEO is perceived as inadequate or overly focused on technical aspects to the detriment of the business dimension. In some cases, the team might lack the necessary technical expertise, leading to issues in product development. Alternatively, we may receive feedback that the CEO struggles with delegation, hampering effective teamwork.
To provide a comprehensive view of the team, we often spend an extended period, typically four to five weeks, immersing ourselves in their environment. This may include activities like having lunch together to gain deeper insights into their dynamics. Our objective is twofold: first, to gauge the soundness of the business and the team's capacity to manage it, and second, to ascertain compatibility between our operational approach and the founders' modus operandi.
To Recap
In summary, team dynamics are paramount in our due diligence process. It takes precedence over other factors. Nevertheless, technology also holds significant weight. Often, there's a debate about whether the team or the technology is more critical. In our perspective, the team takes precedence. Even if the technology isn't groundbreaking or requires improvement, a capable team can reshape it, optimize it for the market, and ensure its successful launch.
In contrast, we've seen instances where an exceptional technology, with no competition and abundant interest, floundered due to a lackluster team unable to navigate the market effectively or provide adequate customer service. The lesson here is clear: a strong team can make necessary improvements to the technology, while the reverse isn't always true.
👩🔬 CTO Seeking a Team: What Are the Options?
In university settings, it's not uncommon to have a Chief Technical Officer (CTO) without a Chief Executive Officer (CEO). For scientific founders who find themselves in this position and are looking to build a comprehensive team, here is some advice:
One approach is to explore various programs designed to connect founders with potential team members. These programs often facilitate matches between individuals with complementary skills. While this method can yield successful partnerships, it may not always feel organic, as you might be pressured to choose from a limited cohort of participants.
In my opinion, the most practical way to build your team is to take the initiative yourself. Start with your idea, work on developing your product, and, if necessary, step into the CEO role temporarily. Even if you're not particularly fond of being a CEO, taking your project forward is crucial at this stage. As you navigate your entrepreneurial journey, you'll likely encounter mentors, advisors, and various support programs, such as incubators and accelerators.
Step One: Seek the Right Partner
While the process isn't instant and may take time, keeping an open mind and actively seeking the right partner throughout your journey is essential. It's worth noting that there's no one-size-fits-all approach. Finding the right co-founder can be a unique and sometimes challenging endeavor.
Scientific founders should also embrace the concept of teamwork and be open to the idea of bringing in specialized expertise. It's essential to recognize that you can't do everything alone. Having a diverse team with complementary skills can significantly enhance your chances of success.
🚀 The Transition from Scientist to Entrepreneur
It's understandable that some scientific founders may initially struggle with the transition to a more business-oriented role like CEO. However, it's crucial to understand that the business aspects of entrepreneurship are entirely learnable. For individuals who have already navigated complex academic and professional challenges, learning about finances, accounting, customer service, sales, and marketing should not be daunting. These subjects are structured and can be acquired through dedicated effort and passion.
Ultimately, I want to emphasize that scientists and engineers are more than capable of becoming successful CEOs if they choose to do so. It's not appropriate to discourage them from taking on this role or suggest that they should hire an MBA as a CEO. Their intelligence, adaptability, and problem-solving skills make them well-suited for leadership positions, and there's no reason why they can't excel in these roles.
Taking that first step outside of your comfort zone can indeed be quite challenging. I can relate to this from my personal experience. My journey involved transitioning from a Ph.D. program focused on hands-on laboratory work, where I wasn't even a theoretical or computational chemist, to a completely different life. In the lab, I was conducting experiments, writing publications, and working with physical materials. However, when I embarked on my entrepreneurial path, my daily routine shifted drastically. I found myself with just a laptop, emails, and the need to engage in activities like writing, reading, evaluating various aspects of business, and delving into financial matters. It was a significant change, and for many, such a transition can feel intimidating.
This shift can be particularly daunting when you've spent several years in a specific academic or professional environment, and you're no longer in your early twenties. However, I want to emphasize that it's entirely achievable. There's nothing inherently challenging about adapting to this new way of life. While it may seem intimidating at first, it's essential to remember that you can embrace change and learn new skills.
This is all for today!
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