A Technical Due Diligence Framework for Early Stage Startups (2024)

Early stage investors face 3 main risks when they assess a startup investment:

(a) Market. Can MONEY be made?

(b) Competition. Can they WIN?

(c) Execution. Can the FOUNDERS DELIVER?

For (a) and (b), we research the competition and do reference calls with early customers.

But the execution risk is also a hard one to understand, because it’s driven by the team. And, you know, people are pretty unpredictable ;-)

It’s the founder’s task to deliver in plenty of domains including, but not limited to, hiring and team management, sales and marketing, fundraising, etc.

Particularly, at the stage we invest at Point Nine Capital, the responsibilities of the tech and product team are:

• To iterate fast to meet the customer needs on time (speed of development)
• To deliver a product that works at the scale needed (reliability)

At the stage we invest, we don’t expect companies to be perfect, but we need to figure out what level of technical execution risk we face. Lately, we have been working on a more standard technical due diligence process to understand that — which we run in a 1 hour call with the tech founder.

By having a more standard process, we hope to:

• Grasp better those risks.
• Decide faster about new investments (“good VCs don’t waste founder’s time”).
• Help the founders understand some of the challenges to come — “unknown unknowns” — so they can figure out how to address them.

We are aware that we don’t have a perfect process.

Now, we want to share it with the community to get feedback and to try to make it more helpful for everyone involved.

Assessment

During the first part of the call, we try to understand:

• How the product has been built until TODAY
• If it will work TOMORROW when success brings trouble. No trouble, no success ;-)

As mentioned, we don’t expect everything to be perfect.

Rather, we try to understand where your product is today, how you’ve built it and what kind of compromises you chose.

There’s no formula for that — most of the due diligence is an art, rather than a science! But as early stage investors we have a privilege: founders teach us how they built their products. Thanks to that, we can develop a sense of what’s achievable with the limited resources of a company at stage.

Also different business models have different requirements — ie. scalability might be more critical for an infrastructure startup than an eCommerce one. What we are interested in is how the team makes decisions in front of trade-offs:

(a) Code ownership: inhouse vs oursourcing

(b) Agility: speed vs reliability

(c) Monitoring: understanding all vs little

(d) Compliance and Security: risks

Learning

It goes without saying, but just in case: a startup is a fast moving and changing environment.

In almost all scenarios, the winner is the one that iterates the fastest. First to find product market fit and then to keep evolving fast to win over competition.

That’s why in the second part of the call we focus on what determines product development speed:

(a) Intellectual curiosity and Thoughtfulness: awareness of the challenges to come is the first step to be ready to solve them in the future

(b) Processes and Tools: should be in place to achieve high productivity

(c) Organization: should be defined to avoid friction and align goals

Teaching

To some geeks, it might sound BS to speak about management skills, but you know what? People like to work with great technical talents AND nice people ;-)

The tech founder of a company is the one who does the first hires. And the first engineers will set the bar and the tone for the next ones. All together, they will give birth to their leadership style and engineering culture.

Caveat: we know there are great technologists who don’t want to (or can’t) deal with hiring and managing people. They can be a good technical founder if they are the only person gifted enough to build that product. In that case, they need a great VP of Engineering ASAP.

With this exception, we like tech founders who are also good at people management:

(a) Leadership: teaching by example and communication

(b) Hiring: attracting great talents

(c) Managing: motivating and keeping those talents

As mentioned before, for Point Nine’s investment process, the technical due diligence is a conversation with the tech founder.

The previous sections are a guideline for that discussion.

But as a toy project, we have turned all those questions into a typeform calculator.

Do you have another 5 min to waste?

Ready to check how would you do at Point Nine’s tech due diligence?

Note: For that calculator, we had to suggest some ratings.

Here is the rationale behind it.

Feel free to comment and to help us improve it!