Any entrepreneur who has gone through the institutional fundraising process would completely understand the pain of due diligence (DD) process done by VCs. Except for talking to your family (and there are instances of indirect reference checks on them as well!), expect the VC to map out your previous bosses, colleagues, co-founders, reportees, friends, investors etc. However, with the entrepreneur and VC entering into the proverbial ‘marriage-that-you-can’t-divorce’, it’s important that founders too, understand their investors in a similar in-depth manner.
There is no better way of doing DD on your prospective investor than speaking to their portfolio CEOs. These are the guys who have borne the brunt of pretty much every stage of the investment lifecycle (total respect for that!), and can give you a feel of the joys and sorrows of having a VC onboard. As peer entrepreneurs, more often than not, they will also be quite candid about their experiences.
A few pointers to keep in mind while initiating this process:
Try and seek out portfolio companies where your deal team is involved – typically, every deal a VC is evaluating will have a deal team. If the investment goes through, these are the guys who will be on your Board as Directors/ Observers, and will be your primary interface with the fund. Keeping this in mind, it’s important to understand THEIR personal working styles and potential areas where they can contribute. This is especially true for General Partners (GPs). It’s always helpful to talk to CEOs of portfolio companies where the specific deal team members are involved, and get a flavor of their professional and personal characteristics.
Important to speak with ventures in your own sector – every VC will have specific strengths in certain sectors. On top of this, specific deal team members too, will have more relevant experience, networks, skills and passion in specific sectors. To gauge how the VC deal team will potentially behave and contribute on the Board, ideally seek out their portfolio CEOs in a space similar to yours. Also, understand their UNIQUE strengths in the space. For instance, IDG Ventures has unique capabilities in software products, mobile and medical devices while ArtimanVentures would be strong in pharma and lifesciences.
Understand broad working styles of investors –All funds and their GPs/investment professionals have a broad working style and portfolio management ethos. You would have typically heard that fund XYZ is very hands-off while fund ABC gets heavily involved in operating issues. All approaches have their pros and cons and as an entrepreneur, it’s important that there shouldn’t be an expectation mismatch.Delving into this aspect via existing portfolio CEOs can help set the correct expectations.
Probe on the VC's contribution to hiring – perhaps the most important role an institutional investor will play in your venture is in helping you scale the team. This could be through referrals via personal networks, hiring a headhunter and helping manage the process etc. Spend adequate time with portfolio CEOs in understanding this aspect, particularly how proactive the VC has been in volunteering time for recruitment efforts.
Appreciating the VC’s role in accessing follow-on rounds – another key role that a VC would play is in helping the company access follow-on rounds of capital. This would be through understanding the next round investor requirements and gearing up the company for it, accessing the most suitable investors and connecting with the right people there, helping with Investment Banker appointment and running the process smoothly etc. Portfolio CEOs that have gone through follow-on rounds will be able to give some great insights into their own experiences with the VC on this aspect.
Exit behavior of the VC is critical – a (sometimes harsh) reality of any institutional investment is that the investor will eventually exit. The process is painful, long drawn out and fraught with several types of incentives at play. Speaking to the CEO of an exited portfolio company will help you understand how the VC behaved during exit process. Although every company will have a unique exit situation, it would still be worthwhile to understand at least softer aspects of the VC’s exit behavior.
Finally, at the risk of sounding like a marriage counselor, a large part of the VC-entrepreneur relationship is based on trust, respect and compatibility. Things like – can you call up this guy at 11 PM at night and vent out? Will he be upfront, honest and transparent during the hold-period? When things are going tough during a follow-on capital raise or in getting an exit, will this guy hold up and stick his neck out for the company? Ultimately, can he be both a friend and a mentor to the founders?
Getting a flavor of these issues will drastically improve your odds of having a positive association with your VC!
If you would like to discuss your venture or business plan, or simply bounce off any ideas, Soumitra can be reached at firstname.lastname@example.org. You can also follow him on Twitter @soumitra_sharma.
The views and opinions expressed in this column are strictly personal, and not those of any organization/institution the author is or has been a part of, nor is made in any official capacity of such organization/institution, unless explicitly stated otherwise. None of the information, views and opinions in the column should be construed as business or legal advice.