Do Your Due Diligence

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This post was originally published in Japanese on TechCrunch Japan.

We recently had an unfortunate incident at 500 Japan. It involved a founder that we were very keen to invest in. We loved his concept, we loved the market he was tackling, and most of all, we loved him. Not only were we very excited to put a substantial amount of our capital behind him, but we were also in the process of getting a great set of value-add investors to join the round.

When you lead a round, it is your responsibility to conduct due diligence. That means inspecting KPIs, bank accounts, and more. Basically, it means investigating whether the numbers stated in the pitch are accurate. Making sure that there are no red flags. This may seem tedious for seed investment, but it is imperative. Even more so if other investors are depending on you.

So that is exactly what we did. We dove into the numbers. We checked the customer contracts. And, unfortunately, we found major discrepancies. Many of the contracts had already expired, meaning monthly recurring revenue (MRR) was significantly lower, and retention was now a major concern.

But worst of all, we lost confidence in the founder. Whether this surprise was due to lack of integrity or lack of attention to detail, we could no longer comfortably write a check. Both scenarios were bad, so we decided to pass.

I don’t write this with any ill-intentions towards the founder. I want to believe that this was just an innocent mistake, and hope that we can remain on good terms. But there are two things that I would like to convey.

One is to founders. Know your numbers by heart and make sure that you can back them up under inspection. It is already hard enough to convince an investor to back you. Don’t ruin it once you’ve gotten as far as due diligence. And it goes without saying, never ever EVER lie about your numbers.

The other is to investors. Do your due diligence. I know that we’d all like to live in a perfect world without mistakes or dishonesty, but unfortunately that is world is idealistic. I heard about a similar incident earlier this year. A group of investors were basically ready to wire the money, when one of them decided to check some figures at the last minute. It is a good thing he did, because they were completely different from what was stated.

I think for all of our sake, we should be more careful.

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