Due diligence at a First Check, Pre-Consensus Fund

How a faux website, backup strategy, and researching “middlemen” companies helped us gain conviction of risks worth taking

Due diligence is so central to the founder / VC dynamic that hardly anyone calls it that, instead using it’s short-form, DD. But while the logic behind due diligence is clear — doing your homework before investing — it’s often quite different from what gets VCs excited: the absence of red flags doesn’t mean the existence of green flags. A company can have nothing wrong with it, but nothing in particular that would build VC conviction to move forward.

As a first-check VC often investing in pre-consensus ideas and founders — i.e. those who don’t check the usual VC boxes — our challenge and our opportunity is digging deeper on due diligence with the dual goal of identifying the red flags and, just as importantly, going beyond the typical indicators of due diligence to build conviction and uncover green flags where others may miss them or choose to wait for future rounds.

So we think about this quite often.

Thinking in risks

Typically, risk is deeply tied to a company’s value and valuation: the greater the risk, the lower they are. Second-time founders, for example, often raise larger sums at higher valuation because the execution risk of more experienced founders is much lower. Similarly, the reason rounds for cyber companies are often larger and priced higher than those in other industries, is that the strength of the ecosystem itself is a de-risking factor: a robust financing ecosystem, a well-known, consistent buyer, and a very active M&A environment.

Given the importance of risk, de-risking is at the heart of the Symbol due diligence process. In our view, companies can be viewed as a stack of risks, and strong companies are those that identify their largest risk at any given moment and take it off the table. Each time you take a risk off the table, you’re raising the company’s valuation, allowing you to further de-risk, and thereby raising the value further, in a virtuous de-risking/value-raising cycle.

At the end, before investing we want to understand three key things: what the risks are, to what extent they can be taken off the table, and, if so, how. For us, the way founders think about their risks — and the strategy they choose to follow in order to de-risk — is key. It’s a strong indication of their ability to navigate the early days of a startup by constantly asking questions and answering the right ones. i.e., de-risking.

Below are some examples of this framework.

NextSilicon

As a deep tech company, the biggest initial risk at NextSilicon was Technology Risk. It was clear that if they could meet their promise of developing a 200X computer processor, there would be a market.

Back in 2017, Elad Raz, the co-founder and CEO, and I spent a few days together in a room with a whiteboard. We were doing prototype architecture designs and back-of-the-envelope yield calculations which gave me a lot of conviction that if there was a technical approach to delivering this kind of performance, this would be it.

NextSilicon actually spent the first fundraising iteration focusing on building a software simulator for their hardware architecture, which provided initial evidence that their technical approach could deliver the results it claimed to. Ultimately, the simulator was delivered to customers while the full-fledged product was being built, which helped build conviction on their side and led to the company’s first contracts.

Jiga

Historically, companies in need of custom manufactured parts either worked directly with vendors in very time-sensitive projects (negotiating, exchanging collateral, etc) OR worked through a “middle man”/third party, which reduced overhead but also created a black box for manufacturers, who had no visibility into the custom manufacturing process.

Not surprisingly, many investors think that selling into manufacturing companies is nuts. The big question with Jiga, then, was Market Risk whether customers would be willing to use a solution that is a middle ground: buying custom parts directly from vendors, but via a marketplace. What would customers need to see in order to be comfortable using the marketplace, and how much would they be willing to pay?

To try and get an answer we went down a few paths:

• First, we researched the big companies in the indirect model — the “middlemen” — and saw that they were doing hundreds of millions in annual sales, indicating that there was a market for custom parts, and also suggesting relatively fast adoption by customers, the seemingly ‘heavy’ manufacturing companies.
• Through our LPs, we were able to connect with potential customers and got consistent feedback that the marketplace approach would be very valuable to them.
• When we met Jiga they already had a few customers. We analyzed those transactions and saw that bigger customers were using Jiga on a recurring basis, which was obviously a good sign.
• At the time of investment, Jiga hadn’t yet cracked the full product-feature set they needed to get people to pay. They also hadn’t cracked the business model with which to go to market (SaaS vs. services vs. transactional fee). But what they were able to do was create a list of hypotheses and a plan for how they would test them: try this business model and this pricing. If that didn’t work, go to plan B, etc. It showed they were thinking very clearly about what the product market fit journey could look like, which gave us confidence that they understood their market and buyers.

WisePal

In the last several years, a general VC consensus emerged that consumer fintech isn’t venture-viable due to very high CAC, and therefore is generally a place to tread very carefully. But while this statement is true on average, our deep dive into WisePal built a conviction that it might not apply here.

In our analysis, consumer fintech CAC is high almost everywhere due to three key factors:

• Intent: most consumer fintech intent isn’t natural or universal. Nobody wakes up in the morning wanting to switch over from their bank. This increases costs at the top of the funnel.
• Funnel: most consumer fintech’s onboarding funnel are high friction, involving going through AML / KYC requirements and answering many questions related to the product. This reduces conversion rates, which increases CAC.
• Competition: most consumer fintech plays are red-red oceans. It feels like every day a new neobank is born. This drives up marketing costs across all stages of the marketing lifecycle.

When analyzing WisePal, we concluded that these three factors don’t hold for the product: the key underlying intent — saving money directly and quickly — is universal and natural. The funnel — one-click connect — is relatively low friction. And there’s comparatively much lower competition.

Once we got past the CAC question, we were left with another WisePal-specific risk, namely that the one-click onboarding funnel required users to connect their personal email accounts— not a trivial ask. We dived deeper into this and got more comfortable:

• Amihay Shmidman, the co-founder of WisePal, built a faux website, on his own dime and time, and started running campaigns to bring users, which allowed him to show a surprisingly high conversion rate — around 50%.
• We analyzed a range of consumer fintech companies with a similar email-based product hook (e.g. Parabus) and through research and LP connections realized some of these companies got to very impressive scale using it.

This research gave us the confidence to lead Wisepal’s pre-seed round, allowing the company to build a real product and start growing.

FundGuard

Selling to financial services companies is notoriously difficult. So difficult it was considered to be a no-go for VC backed companies. They all use the legacy, on-prem systems that are deeply embedded in their workflows and are considered to be impossible to replace due to multi-year contracts and high-friction change management. On top of that, sales cycles are extremely long (think years, not months), and the customer universe is sometimes limited.

But if you somehow manage to crack the distribution/adoption part of things, you find yourself in a lucid blue ocean of demand for cloud products and have a shot at ultimately capturing the market.

The FundGuard founders came up with a clever strategy to do just that. Instead of trying to replace the system from day one, they took advantage of the fact that these systems, because of their legacy status and underlying infrastructure, occasionally had blackout events, leaving customers with no access to data or financial metrics they needed to report. FundGuard positioned their product not as a replacement, but as a backup (contingency) system, which made adopting it less risky and quicker, and helped FundGuard build customer trust over time to eventually replace the primary systems.

“One more thing”

One last point about due diligence. For us, it’s not about having the answers — these are complex issues with no easy answers. Rather, it’s about founders having clear — and often creative — thinking about how we can work together to better understand and hopefully de-risk. And while risk has negative connotations, for us it is both an opportunity to truly understand a company, and also to find the pre-consensus companies where smart de-risking is the difference between a red and green flag.