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How to Diligence Your VCs

Your relationship with your investors doesn’t end when the money is wired. Adding a new investor to your board or cap table is like getting married – for better or for worse, in sickness and in health. And in the same way you (likely) wouldn’t marry someone after the first date, you shouldn’t sign a term sheet with an investor without doing your own diligence first.

The venture industry isn’t designed to make this easy. Founders typically will only raise venture financing a handful of times in their lives, whereas VCs have years to build processes to vet companies and founding teams as potential investments. It’s not an even playing field. Instead of attempting to build your own process, steal from the other side of the table.

Diligence your investors the same way they’ll diligence you: with backchannel references. Ultimately, there are two types of investors – one of which you’ll want to avoid at all costs.

As both a founder and now an investor, I’ve had experience working with both types of VCs: fair-weather investors and all-weather investors:

  • Fair-weather investors are the stereotypical, hard to work with investors: flakey, difficult to get ahold of, and only helpful when things are going well. Having them on your board might be great when things are going well, but the second you stumble, they’ll disappear.
  • All-weather investors are helpful even when your company is struggling. They’re available and sympathetic when you’re not hitting metrics, when there’s conflict on your board, or you’re not sure how to progress.

Start by asking for “on-list” references.

You should feel comfortable asking a potential investor for a list of portfolio executives that could serve as references. The vast majority will have them readily available and should be happy to connect you.

Here’s something I wish I knew as a founder: asking for investor references is a positive signal for VCs. It demonstrates a thoughtful approach to fundraising. And while fundraising can be an orthogonal skill to operating a business, thoughtfulness here frequently carries over to hiring, sales, and other essential parts of starting a company.

On-list references are only the beginning of your diligence process. To truly diligence your potential investor, it’s important that you go deeper.

Find your own “off-list” references.

On-list references can be helpful, but the most useful conversations will likely happen with people that your investor isn’t keen to introduce you to – your off-list references.

Every time you talk to an on-list reference, ask that person for introductions to 2-3 others who have raised money from the same investor. Another good place to look is your potential investor’s website, AngelList page, and Crunchbase profile for companies that worked with your specific potential investor. Wherever you find off-list references, look for companies that have shut down or struggled. They'll frequently be the most candid and can help you determine whether your potential investor will stick around during difficult times.

Schedule reference calls with every company you can find.

For your on-list references, this should be relatively easy – your potential investor will facilitate an introduction and let you two chat.

For your off-list references, you may need to get creative. Like in almost any area, warm introductions are king. An on-list reference or founder you know already is the best introduction, and looking at mutual connections through Twitter, Facebook, or LinkedIn can help facilitate that join.

If all else fails, just reach out directly with a short, succinct email. From personal experience, many founders are happy to chat for a few minutes about investors they’ve worked with once you have a term-sheet in hand. If they’ve had a stellar experience with the investor, they’ll want to pass on an endorsement. And if they’ve had a less-than-stellar experience, they’ll likely want to help you avoid the same fate.

Prepare a list of questions.

While general questions can be helpful, I’ve found it’s most useful to dig into specific elements of a potential investor you’d like to diligence. You might want to ask about their ability to be engaged during board meetings. You might be curious about how they -- and their firm -- handle themselves when companies struggle, or you may want to dig into their working style to see if it meshes with yours.

Start your call with general questions designed to unearth potential problem spots. Have questions prepared to dig deeper on a given topic if a reference’s answer conflicts with what you might expect. That combination -- opening with general questions and digging in with deeper, specific ones -- can help you identify the biggest potential problems with an investor.

Here are some general questions I can recommend:

  • How would you rate your experience with this investor out of 10? No one will say 10 -- they’ll likely answer 7-9. When they do, ask what the investor could improve to be a 10.
  • At what stage of your company was this investor most helpful? At what stage were they least helpful?
  • What was your experience like with this investor on your board?
  • How did they approach problems with the business? Conflicts on the board?
  • What surprised you most working with the investor? With the firm?
  • What was your experience with this investor’s personal conduct?

Review any lingering concerns with your potential investor.

Assuming you don’t find any deal-breaking red flags, schedule a meeting to review any lingering concerns with your potential investor.

In addition to questions related to your reference calls, consider asking the following:

  • Who are your LPs?

    Great investors tend to have great LPs. You should know which individuals or institutions are supporting the fund you’re raising from so you can be aware of any potential ethical landmines.

  • What’s the best way to take advantage of the resources your fund offers to teams?

    Funds are increasingly investing in operational expertise to help founders hire and scale. While many investors will say they offer a platform team, asking specifically about how to best use their resources can be a great way of seeing how helpful they are.

  • How does your firm handle involvement in future financing rounds?

    At different stages of your company’s lifecycle, you may want investors with different approaches to future rounds. Early on, you may want an investor willing to write a second check to your company to extend their runway. An investor who can help put together a syndicate for your next round -- or help you run a tighter process -- will also likely be helpful.

“Picking an investor is like getting married -- without the option of divorce.”

At the end of the day, you’ll have to apply your own judgment to the feedback you get from on-list references, backchannels, and your own discussions with your potential investor. Nothing will be a more effective filter than your own experiences with your potential investor.