Entrepreneurs, do your diligence on VCs.

December 8, 2012

When I am in the term sheet stage with a company, sometimes (maybe half of the time) I’ll hear that the company Founder or CEO is calling around to my current portfolio companies to get the scoop on our fund and how I behave as a board member and investor.  It ALWAYS makes me feel better about the investment if the Founder or CEO is smart enough to do this. It is the same level of thoroughness and thoughtfulness that will be needed after the investment in evaluating partners, future employees, customers, etc.

My guess is that company teams do anything more than cursory diligence only about half the time  – maybe we should make it a final “pop quiz” before funding by asking them “what did you find out about us and how did you do it?”

Entrepreneurs should  not hesitate to ask the potential investor for introductions to portfolio company CEOs and Founders.  To be honest, only one founder has ever done this in my personal portfolio – maybe teams are are worried about offending their potential investor so call around quietly.  My 2 cents is that you should run away from a VC investor that does not appreciate that the company should do some due diligence just like an investor so go ahead and ask for the contacts.

Here is my advice to entrepreneurs:

You should feel free reach out to the CEOs and founders in the VCs portfolio.  Ask the VC for the contact, or not, as you wish.  It probably makes sense to tell the VCs that you are doing it (at minimum to see how they react).

You pick which of the portfolio companies to call.

Recognize that CEOs that were hired in by the VC will almost always be positive and CEOs hired in later, when more VCs are in the deal, are likely to know less than perhaps a founder that was there at the start (many of our companies have scientific founders who participate in hiring CEOs later).

Ask about how the VC handled unexpected setbacks.  Did they panic? Did they demotivate the team? or did they support the CEO?

Ask about how the VC looked at difficult financing situations in the past.  Was it simply a chance to get a financial advantage or did the VC think about things like fairness?  Was the VC working to make the pie bigger for everyone or just have more pie for themselves?

Ask whether the VC style focuses on helping to solve problems or whether the VC is a micromanager

Recognize that people come and go in startups for lots of reasons – not everyone will be happy all of the time and everyone has a deal where lots of people are unhappy.  When my oldest daughter was applying to college, I spent some time looking at the student reviews of their own colleges and decided that the key metric was “Would you go there again?”  My recollection is that the best rankings were at around 85% and the big name colleges often were somewhat lower.  It feels like the same thing applies in VC – even the best don’t score 100% and the biggest names don’t always get the best “I would go there again.”

Finally, go back to the VC and tell them about what you learned, it is a good way to build the relationship and get some additional insight into the person you will be working with for the next 2 to 8 years.


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