The perils of doing due diligence on startups

Dear readers,

There’s a good reason why startup investing is considered risk capital – vetting startups and founders is difficult.

In the early stages, venture capitalists can’t rely on a startup’s past financial data to make decisions as there’s often no such history to look at. Instead, VCs have to judge the character of founders and predict how well their startups will do.

But an investor told me that there’s another challenge that’s not so obvious: They can’t push for too much information without coming across as overbearing and paranoid. Doing so might drive the potential investee into the arms of a rival that’s perceived to be friendlier to startups.

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Two of our recent stories have to do with this due diligence process.

After the Singapore High Court ruled against Sy Phong Bui, the founder of Vietnamese company Telio, in a lawsuit with his former startup, we raised the question: Did Sequoia India do enough due diligence on Telio?

It’s another way of asking when and what did Sequoia know about Bui’s dispute with his previous investors? And if the VC firm did know, what did it make of the conflict?

These lead to even more questions about different areas. For instance, what’s next for Telio, since the judge has ordered Bui to distribute Telio shares to his previous investors? Will this set a precedent for other investors who are in similar disputes with founders they’re backing?

Bui is set to appeal, so the verdict may be overturned. We’ll see.

On another note, we also discussed whether the Envy misstep will tarnish what could be Vickers Venture Partners’ best year.

It appears that Envy, which allegedly fooled many investors in a fraudulent investment scheme, bypassed many due diligence checks.

Envy isn’t a tech startup, of course, but what happened brings up the same concerns. Can any VC reliably suss out a company that takes the mantra “fake it til you make it” too far? Or is this a risk they have to accept?

Without naming names, we’ve heard from sources about the ways in which startups might try to pull a fast one on investors: