Once in a while I meet a startup that makes me scratch my head in bewilderment. At first glance everything looks fine, but I can’t help but wonder if I might be missing something. In such instances I think to myself; Is there some important detail that is not so obvious, and that is concealed such that my normal due diligence efforts might not be enough?

I am not suggesting that anything is concealed in an attempt at dishonesty. It is just that under normal circumstances certain pieces of information do not seem relevant and so for purposes of brevity, such information is excluded from the information that is shared with potential investors.¹

Historical analysis can prove useful under such circumstances.² What is a historical analysis?³The fundamental goal of a historical analysis is to understand if there are signs from the past in a startup’s existence that give some indication about what a potential investor might expect in the future. In my analysis I will be looking for patterns of past behavior, activity, choices and trade-offs that may affect the way the startup functions now, or how it might function in the future. An effective historical analysis must look at the startup’s history through various phases of its development. Such analysis must also study the startup’s leadership, how the startup has navigated various crises, its strategy, and its culture.⁴

Historical choices have a direct connection to the strategic options that will be available to the startup. For example, historical choices affect operations, technology, and infrastructure. The capabilities that the startup builds internally versus the capabilities that it acquires through partnerships with external organizations are directly related to choices that were made in the past. Such choices directly affect where the startup faces the greatest risk and uncertainly in its business model. Certain past choices will constrain the startup’s ability to pursue new, previously unforeseen opportunities in the future, while other past choices will give it enough flexibility to make rapid adjustments to keep up with new developments in the market.

Most historical analyses look at events after the fact and mainly focus on connecting the dots between the past and the present. In the context of an investor studying a startup, connecting the past and the present is important, but more important is connecting the past with the present and then extrapolating to possible outcomes in the future.⁵

Here’s a list of questions that I might start with in conducting a forensic historical analysis.⁶

1. What is the original hypothesis that led to the formation of this startup? How did that change over time? If it changed, why did it change? Has that shift proved to be one that will benefit new investors or is it one that will  be a disadvantage? What does that tell me?
2. Given the amount of capital that has already been consumed by the startup, would one expect more or less progress than has already been made in solving the problem it set out to solve? Why? If less progress has been made than one would expect, is that a result of reasons I feel can be justified objectively, or did the entrepreneur make costly but avoidable mistakes along the way? How do I know that such mistakes will not be repeated in the future? What does this tell me? Are there signs to suggest this entrepreneur will continue to make mistakes that hinder the startup’s ability to succeed? Why?
3. What promises did the entrepreneur make to previous and existing investors? Do those investors feel that the entrepreneur has fulfilled those promises?⁷ How has the startup performed against its historical budgets and operating targets? What does that tell me about what I should expect in the future?

Many more questions need to be asked, but this is a good start. Ultimately, my goal is to decide if I should say yes or say no.

1. For example, decisions made 3, 4 or 5 years ago might not be explained in any great detail in the due diligence documentation. ?
2. One might describe this line of analysis as a forensic historical analysis. While the conclusions of this analysis are not shared with a court, the investor will use the results of this analysis to argue for or against an investment in the startup. ?
3. I am relying on a paper I wrote in my Global Perspectives on Enterprise Systems class at NYU Stern for inspiration. If you are interested you can read my analysis of Toyota and Deutsche Bank here: PDF – Ceteris Paribus, Does History Matter? ?
4. Numerous academic studies suggest that a startup’s culture is directly and significantly affected by the behavior and cultural norms of its founders and the founding team. ?
5. This is not as straightforward as it might seem. I attempt to study the question of relying on experience to predict a startup’s future potential here: Tekedia – How To Recognize, Hunt And Invest in Big-Game Startups. ?
6. This only serves as a starting point. I would need to create a specific list of questions for each case. ?
7. It is not enough to look only at financial returns, because past results might not be sustainable if the startup’s choices have locked it into a rapidly deteriorating position. ?