Story from Fred Wilson: "You Can Do Too Much Due Diligence"

This story is from Fred Wilson, partner in Union Square Ventures and someone who's frequently referenced on this site. For more on due diligence, see this article I wrote for 99u last year, and of course check out the book.

May 132013

You Can Do Too Much Due Diligence

It's Monday, time for another lesson I've learned in the venture capital business. Today I will tell a story that I love telling. It has some of my favorite people in it.

Back in 2004, early in my blogging career, I heard about a service that had just launched called Feedburner. It provided a number of useful services for a blog's RSS feed. So I went and signed up and AVC became one of the first users of the service. I immediately liked the service and the idea. So I contacted the founder/CEO Dick Costolo, who has gone onto bigger and better things. I told Dick that I was interested in making an investment in Feedburner. My friend Brad Feld was also talking to Dick about the same thing so we decided to do the investment together.

As part of our investment process, we do a bunch of fact gathering/checking work that is called Due Diligence in the vernacular of the VC business. So my partner Brad Burnham and I put together a list of leading blogs and online publishers who had popular RSS feeds at the time. I think there were a dozen or so publications on that list. It included Weblogs (Engadget), Gawker (Gawker), NY Times, and a bunch more. We know most everyone who ran those operations so we called them.

What we heard was surprising. Not one of them was willing to hand over their RSS feed to a third party for analytics and monetization. We were very surprised to hear that and thought a bit about it. But, we decided, we could not invest in something that the big publishers would not support. So regrettably, I called Dick and told him we had to pass and why. Brad Feld went ahead with the investment and Feedburner closed their round without USV.

About six months later I ran into Dick at an industry conference. We decided to grab lunch together and during lunch he said to me "you know those dozen publishers you called?" I said "yes, what about them?" He said "every single one of them is on Feedburner now."

I was pissed. How could that be? So I said to Dick, "Would you consider letting us into that last round we walked away from." He said "No, but I will let you invest at a 50% increase in price". We did that and became an investor in Feedburner. And that worked out well when Feedburner was sold to Google a few years later.

So what did I learn from this lesson? First, trust your gut. I was using Feedburner and knew it was a very useful service. I felt that others would see that too. They did, but it took some time. Second, I learned that a service can get traction with the little guys and in time, the big guys will come along. I have seen that happen quite a bit since then. And finally, I learned that you can do too much due diligence. It's important to talk to the market and hear what it is saying. But you have to balance that with other things; the quality of the team, the product, the user experience, etc. You cannot rely alone on due diligence, particularly early on in the development of a company and a market.

I posted the following as a comment to Fred's post:

"Don't overdo due diligence" applies to entrepreneurs as much as investors. If you investigate any idea enough you will find ample reasons it won't work. If you are a strong believer in your idea (or the people behind the idea), better to try some small, cheap steps rather than continue to think about it or back away. The direct evidence you get from those early steps is far more illuminating than any arms-length due diligence you can do.

I liken working with early stage businesses (as investor or founder) to driving at night on an unfamiliar road. There will be curves up ahead which are beyond the reach of your headlights. All you can do is drive under control till what is up ahead becomes visible. But better to drive than wait. If you wait till daytime, you will be late.

A thought on due diligence

The following was posted as a comment to the old Ning Mistake Bank site. It's part of that site's archive but I no longer know who wrote it. Whoever it was, they were pretty wise:

Several of the stories posted on the site are on lack of due diligence causing problems later. However, we rarely look back on situations where we did too much due diligence. What opportunities did we not take because we looked too closely at them? Might some of them turned out great? I think circumstances influence our level of due diligence, especially when we're self-employed. When you need that next gig, or really want to make a certain deal, our brains look at the bright side and muffle our skeptical side. Sometimes that causes us problems, and sometimes it turns out great.

By the way, if you were the person who posted it and would like attribution, I'm happy to give that to you. Post a comment and I'll get in touch with you.

...and after rereading this post, it occurs to me that a tool that addresses this is possible. Something like an "reverse due diligence" - looking at the absolute worst case outcome of a decision, and comparing it to the possible upside, as a rationale for going ahead with the decision.

Jocelyn Glei: making and recovering from a poor job transition

Jocelyn Glei from shared a terrific mistake story and lessonon The99Percent.com. Here is the start of the story:

One of the biggest mistakes I made was a poor job transition in 2007. I had been working for an exciting startup called Flavorpill for a little over 4 years. When I joined in 2002, the company was expanding, and I had the opportunity to assemble an editorial team, collaborate with the founders on growing the brand, and work closely with our wonderful design partners to build and launch new products. It was a great job and I learned a ton. But eventually, I knew it was time to move on.

A friend connected me with the CEO of a massive music website that wanted to reinvent its coverage for a new, hipper audience. He was looking for an editor with a vision. I didn't like their current website, but the allure of having carte blanche to reinvent the site was strong. I was also offered more money than I had ever made, and the opportunity to relocate to Los Angeles. I was ready for a major change, and this seemed like the perfect way to shake things up.

As a result, I probably didn’t do as much homework on the position as I should have. After just a few weeks on the job, I realized something was amiss....

Please go to The99Percent.com to read the rest.

When hiring a marketer, "I didn't insist on being heard"

Marcia Pledger's "My Biggest Mistake" feature from The Cleveland Plain Dealer remains one of the best resources of mistake learning you will find. This story is from Rachel Friedman, founder of A Better Pet.

My biggest mistake was not trusting my gut instinct in hiring someone for an area of running a business that was not my area of expertise....

I hired someone to help market my product based on a referral from someone whose opinion I respected. The problem was, it didn't occur to me at the time, the degree to which familiarity of my industry was key to marketing.

When I hired the marketer, I brought up my concern. Their response was, you don't need to be an expert in an industry to market a product. It didn't feel right. Even though the person was a qualified and experienced marketer, I ignored my gut instinct....

I ended up spending about a third of my entire budget on marketing but got what I felt to be very little return on the investment. For instance, a big chunk of money went toward preparing for and participating in a tradeshow at a dog training conference.

The product has evolved to include companion and working dogs, ranging from urban strollers on leashes to off-leash hikers. But early on, the first people who embraced it were people using service dogs, who knew what else was out there - less versatile and less functional vests.
You never know how any marketing campaign is going to go, or even who will be your end-user for sure. But I firmly believe it's best to aim for your target market when you're starting out. Even though my product fits any dog, I invented it for the working dog industry. My work in training service dogs was the inspiration for the product. Service and therapy dog organizations were first to embrace the product, not pet dog trainers.

If I had hired someone familiar with my industry, I would have been able to communicate with them in shorthand and not have to reinvent the wheel. It costs time and money to educate people about your industry. We weren't on the same wavelength.

I learned from the experience. Even though I don't mind hurting a pet owner's feelings to help them get their desired results from training, I used to be a wimp in dealing with professionals I hired to help build my business. I didn't insist on being heard.

Max Weinberg of the E Street Band: Not doing research in a real-estate transaction

From the April 11, 2008, issue of the Wall Street Journal.

In 1984, [Max Weinberg and his wife Becky] paid $300,000 for a five-acre farm that was part of a development, also in Monmouth County, and learned a lesson that Mr. Weinberg hasn't forgotten.

The Weinbergs bought the property, part of a subdivision, from the developer, who initially planned to keep the farm for himself. The developer seemed impressive -- he wore fancy suits and drove a Cadillac -- but he was deeply in debt and needed to make a deal, Mr. Weinberg says. But Mr. Weinberg didn't know any of that -- and he didn't dig into the deed records that might have revealed it. (Mortgages usually are attached to deeds.)

After the deal was done, the seller pulled Mr. Weinberg aside. "You paid me too much for the house," he told him. "I was up to here in debt. I needed the money."

"Why didn't you tell me this 10 minutes ago?" Mr. Weinberg recalls asking.

"That's business," the man replied.

In the end, Mr. Weinberg made money on the deal -- he sold the house for $590,000 in 1997, records show. But he knows he could have had the house for less, and he says he resolved never again to be out-researched on a real-estate purchase. He credits that lesson with helping him in later deals, from his current land, which he bought in a complex transaction involving a land swap with the seller, to a house he's considering buying in Tuscany, Italy, for which he has studied up on wild boar, a local nuisance. (They can burrow, he has learned, but they can't jump.)

"My whole thing has been research," he says. "All the answers can be found in city hall."

James McCann of 1-800-Flowers on recovering from poor due diligence

From the New York Times, Sunday March 16, 2008, an interview with 1-800-Flowers.com CEO James McCann:

In 1986 I bought the assets of a failed floral company in Texas called 800-Flowers and took that name. I thought I was smarter than everyone else and neglected to hire lawyers and bankers to do due diligence. I unknowingly signed for all liabilities, which I later learned was a debt of $7 million.

People advised me to file for bankruptcy. Then my grandmother took me aside and said: “This bankruptcy thing? We don’t do that. Find another way.” I worked like an animal to get out of that hole....

If you look at highly successful people, they make the same number of mistakes as others, but they recover quickly. They don’t sit around moaning about what they’ve done wrong.

A more complete retelling of this same mistake can be found in this article in Inc Magazine.

Incomplete due diligence in a real-estate transaction

Continuing our look at successful entrepreneurs and the mistakes that shaped their careers. This video was part of the Mistake Bank Ning site, and I was reminded of it as we toured the city of Wilkes-Barre, PA, last weekend. My wife was driving, and from time to time she'd point to a building and say, "My dad owned that one."

This story was from the beginning of my father-in-law's real-estate investment career, and to me says a lot about due diligence. I've heard many entrepreneur mistake stories where inadequate due-diligence was at the heart of the issue. On the other hand, diving into a deal without having everything figured out, and then making it work, eventually brought these business owners to another level of success.

So: mistake or bold move? Discuss.


Don McFadden on Due Diligence in a Real Estate Transaction - a Mistake Bank story from John Caddell on Vimeo.

Not doing my financial due diligence

John Caddell describes the dream of a career--being able to become part owner of a business--and what he learned after he was afraid to ask too many questions before signing on.

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