Why Should Your Firm Conduct Human Due Diligence?
In this article, we will focus on human capital. In particular, we will go through what human due diligence in venture capital is, its importance, and some prime examples of what can go wrong.
What is human due diligence in venture capital?
In venture capital, human due diligence is the meticulous process of examining startup founders and core leaders to see if they are likely to be high performers and fulfill their stated business goals in the future. Moreover, this research procedure ensures that entrepreneurs are who they claim to be. While HDD is not the only component of the due diligence process, it is undeniably one of the most important. Despite this pressing need, most investors lack the objective data required to appropriately evaluate founders. Traditional techniques of human due diligence, such as interviews and reference checks, are time-consuming, expensive, and provide little predictive value.
Why is human due diligence important?
We will considerably lower the likelihood of further serious difficulties affecting the startup, and in the worst-case scenario, losing important employees and reducing development, losing market share, impeding growth, and slowing desired change much more than is generally the case. In addition, we may identify skill gaps and decision-making issues while also recognizing key strengths and using them to add more value to the overall due diligence process, both statistically and qualitatively.
When Human Due Diligence Goes Wrong: Real World Scenarios.
Elizabeth Holmes-the American fraudster: In 2003, Elizabeth Holmes founded Theranos, a company that focused on diagnosing diseases. At the time, it was deemed revolutionary as this company ensured that its Edison test could detect cancer and diabetes quickly by only using a few drops of blood. Powerful individuals were intrigued and invested even though they did not see certified financial statements. As a result, Theranos received over $700 million in funding from investors (including billionaires Rupert Murdoch and Larry Ellison), who valued the firm at $9 billion. Interestingly, Dr. Jeffrey Flier, the former dean of Harvard Medical School, was extremely impressed with Holmes’s confidence and capability even when she couldn’t answer his questions regarding the company’s technology. In 2015, there were concerns regarding Theranos’s Edison test. The Wall Street Journal published a series of stinging exposés alleging that the findings were inaccurate and that the company had been doing most of its testing on publicly accessible devices built by other manufacturers. As lawsuits started piling up, prosecutors found that Elizabeth Holmes purposefully deceived patients about the tests and inflated the firm's effectiveness to financial supporters. As of now, the founder just stated that she could not afford to pay back $250 each month to her victims.
Adam Neumann: In 2010, Adam Neumann and his co-founder Miguel McKelvey founded WeWork, which provides coworking spaces (including physical and virtual shared spaces). In 2014, investors such as Goldman Sachs Group and Wellington Management invested in the company. In 2017, the Japanese SoftBank Group invested $4.4 billion into the company. While WeWork’s value was on the rise, there had been doubts about Neumann’s lavish lifestyle, the firm’s difficult working environment, and its ability to live up to its valuation. In 2019, as WeWork was looking to go public, investors expressed their concerns about the company’s true value after looking at its financial statements. Neumann was under the spotlight because it was revealed that he had been charging WeWork for personal expenses. The failed attempt to do an IPO, WeWork faced the possibility of bankruptcy, and Newmann was forced to resign from the board.
Due diligence is a procedure that should not be underestimated in any type of investment, and this case is especially true for human due diligence in venture capital. To put an emphasis on what could go wrong, we have provided you with two major examples above, which are Elizabeth Holmes’s Theranos and Adam Neumann’s WeWork.