Due diligence has many aspects. Some areas include finance, legal, management team and market. Yet, the most overlooked area in due diligence is innovation.
Innovation Due Diligence Can Be Broken Down Into Three Parts:
I. The Two Questions of Real Problems
Conducting due diligence on innovation all starts with two questions: (i) Does the company’s product solve an offline problem? And has this solution existed before, or is it new?
True innovations solve real, offline problems in a way that no other solution could before.
II. 30,000 Foot View
For venture capitalists, their job revolves around recognizing innovation, and putting it into perspective. This perspective, which many consider the “30,000″ foot view, is what VC’s spend their time doing. Building perspective involves the following activities (also, this is not just for VC’s. If you want to thrive in your sector, you must also have a pulse for innovation):
- Adding every major blog in your sector to your RSS Reader (and reading your RSS daily)
- Finding every blog in each niche that you’re investing in, and adding it to your RSS Reader
- Attending every trade show and conference related to your market
- Networking with other VC’s, industry experts, investment bankers, technology analysts and hedge fund partners in order to get a pulse for the market
- Observing every executive summary that comes your way (don’t pass anything up)
When you have an in-depth understanding of your market, you can quickly spot whether or not something is worth looking at. I remember a couple years back when every idea sounded revolutionary. It was because I didn’t have a pulse for innovation. I didn’t have the 30,000 foot view yet.
III. Degree of Solution
The final step when conducting due diligence on innovation centers on the degree of the solution. Is the product solving something that is a significant problem, or is it a “nice-to-have.” This can be deceptive because a beautiful technological achievment can be an, “eh, that’s nice to have. That’s pretty cool.” Yet, investors will still throw cash at the product because it’s a technological achievement. You’ll see this happen a lot at the MIT’s, Cal Tech’s and Harvey Mudd’s. It’s called Mousetrap Myopia, in that engineers and scientists will be fascinated with the product because it’s never been made before, but at the end of the day, it doesn’t solve a real-world problem. It’s on the company to demonstrate how the solution genuinely solves problems.
