Prior to making an investment in a company, every venture capitalist (VC) completes a due diligence list––a catalog of the key business assumptions they need to validate prior to closing an investment. These lists vary depending on the stage of the deal and can range from your articles of incorporation to detailed customer calls.
This is a good thing. People should know what they’re getting into. Unfortunately, many entrepreneurs forget that diligence is a two-way street. Or, just as dangerous, they overemphasize a few key items. Things like the hotness of a firm, the valuation given to your company, or even the option of board members on fit become big factors driving their choice. While these are clearly important, they are not the only factors that matter.
Getting venture financing is more like a marriage than a financial transaction. After closing, you’ll be in bed with your VC through good times and bad. Not only will your VC be riding alongside you on the inevitable roller coaster associated with any new venture, but you’ll be on your VC’s ride as well. Yes, VCs have problems too. You will be dealing with all of the inter-family relationships that come with bringing a new firm and fund into your boardroom. Making a deal solely based on how hot their firm is at the time is akin to picking your spouse based on looks. Looks fade. And, if you’re not careful, you’ll find yourself in the middle of a messy divorce. Unfortunately, sometimes it’s easier to get a divorce than to get the wrong investor off your cap-table.
Below is a framework you can use to help evaluate your potential fit with a VC. There are four things you should evaluate when considering an investment: the firm (e.g., Andreessen Horowitz), the fund (e.g., Fund I), the VC (e.g., Marc Andreessen), and the board (e.g., how does Marc fit your board). For each category of diligence, try to ask the same questions from their past and present entrepreneurs. Remember this is a framework, not a silver bullet. The weight you place on these items will depend on your experience, company stage, and preferences.
Though I can’t promise that this will save you from the issues ahead, I can promise that you won’t regret getting to know who you’re getting in bed with for the next couple years.
While your VC ultimately has the largest impact in the boardroom, make no mistake, their firm’s culture will ultimately impact your board culture. Like marriage, you don’t just marry the person, you marry their family. Your VC updates partners every Monday. If they have issues at work, they’re bringing them back home to you. Also, investors can sometimes have one of their peers take their seat. This is often another person from their firm, so make sure to get to know them. Some questions to ask to learn more about the firm:
- How long do the firm’s investments typically last?
- What is the firm’s history of exits, especially in your sector?
- Is the firm strong in your sector?
- How have the firm’s most recent funds performed?
- Do other partners in the firm fit your culture?
- Is their risk preference aligned with yours?
Each venture firm will invest in you from a fund they’ve raised. Each fund may have different objective and history. As such, fund dynamics color your VC’s decision space. When the smoke clears and the honeymoon is over, your VC is there to make money. If your company raises money from a fund that isn’t performing, chances are that your VC is going to be rooting for an exit sooner rather than later. Moreover, they might not be able to pony up during a round, which makes for an awkward and sometimes even fatal discussion. Some questions to ask to learn more about the fund:
- What fund is your company going to be in?
- How is success measured for the fund?
- How large is the fund?
- How have previous funds performed?
- What other companies are in the fund?
- How much of the firm’s current fund is deployed, or reserved?
If you do one thing well, do this––get to know your VC. This is your partner. Is this someone you can trust in a foxhole? Do they see the same future as you do for your company? As a young entrepreneur, if you align with someone who has exited an investment and has fewer board seats, you’ll have a markedly different experience than working with a rookie trying to build a rep. Some questions to ask to learn more about the VC:
- What is the VC’s track record?
- Does the VC have operational experience?
- Do they have experience with your market and business model?
- Is the VC thesis-driven, and does their investment thesis align with your own view?
- How many boards is the VC serving on, how many will they join, and for how long?
- Does the VC back founder/CEOs, or do they have a history of moving to hired guns?
This is the most overlooked factor in any entrepreneur’s due diligence. The CEO owns company culture, but the CEO’s ability to steward culture is a function of the support they receive in the boardroom. If board members’ expectations are not aligned, things will go downhill––fast. As such, it’s critical to get the right folks on the bus. Think more like Moneyball versus an NBA all-star game. If this is your first board member, this choice is even more important. And, unlike your management team, it’s not that easy to change your board––so choose wisely. Some questions to ask to learn more about the board:
- How do the goals of the board line up with those of the new VC?
- Does the personality and experience of the new VC compliment the rest of the board?
- Will influence change in the new structure?
- How will voting work in the new structure?
- Does the VC sit on any other boards with your current board?
- Does the VC have any history of fall-outs, or problems on other boards?
Hooman Radfar is an entrepreneur, executive and investor with demonstrated experience in product development, strategy, operations, financing, and M&A. He has deep expertise in social platforms, big data infrastructure, and online marketing. Hooman is co-founder & chairman of AddThis, the world’s largest social infrastructure and data platform for publishers and advertisers. Reaching 1.3 billion unique users monthly, AddThis social plugins and analytics are used by over 14 million web sites to increase traffic and engagement. AddThis’ social data platform enables over 500 brands to reach connected audiences around the world in real-time via ad exchanges.
Follow Hooman on Twitter: @hoomanradfar