I am often asked by the founders of our portfolio companies how to decide which new investor to focus on and finally choose during a new financing round (provided that the start-up is lucky and confident enough that they end up with several term sheets from different VCs 😊 ). Investing equity in a new venture means a very long relationship between the founders and the venture capital partner. I learnt from some founders that they regret not having done a decent due diligence on their investors before signing the shareholders’ agreement. This is why I decided to write this short article in order to reflect my experience and give (hopefully) some advice to founders from a VC’s perspective.
The personal network of the potential VC is important. By network, I mean the real contacts to other investors. Has he or she made many syndicated investments or helped his portfolio companies to get a follow-on investor through his network in the past? Moreover, a good network includes people within the industry or business model the start-up is operating in, e.g. a pure software investor will probably lack that network in the biotech space.
Related to a good network is knowing potential candidates to fill vacant first or second level positions. Frankly, this is often a very rare competence to find. Nevertheless, a descent VC should know where to find support for recruitment within the designated industry and be able to advise founders, e.g. by conducting interviews for important positions.
Synergies to other portfolio companies
Also related to a professional VC network are contacts to founders in the same industry. As a first time founder, learning from similar peers is crucial to prevent mistakes. E.g. if the VC has done several e-commerce investments in the past, it will be of a high probability, his network is profound in that area.
As a founder thinking about raising venture capital, you should also think about bringing expertise into your company (apart from the money). If someone has never done an e-commerce investment before and never been on a board seat in that kind of a company, it will be hard to get some experience in terms of KPI benchmarking, operational excellence etc. in this particular industry. I do not claim that the entire VC fund must be focused on one industry, but the partner responsible for the venture should have experience in the industry and business model he invests in.
The other partners of the VC fund
We as VCs analyse how complimentary the founders are in terms of personality and functional expertise. Although, you will be primarily in contact with the one responsible partner leading the investment, it is advisable to get to know the other partners of the VC fund pre-signing the deal. VC partners might leave the fund or the expertise of another partner might be relevant for your business. Apart from partners, meet the associates or principles of the relevant VC fund. They might be promoted in 1 or 2 years and suddenly you have to deal with them as a board member.
Follow-on financing capacities
Most VC funds have a certain focus on the stage and size of financing. Do not expect that a new investor having led your Series A round, will be also lead investor of the Series B. Nevertheless, find out how many financial reserves the investor allocates on your company for next rounds. This is important for follow-on investors as positive signalling, but also for less glory times when the company develops slower than expected and a bridge financing is needed.
Apart from the hard facts, a new investor will be part of your (professional) life for a couple of years. Therefore, analyse a new partner also in terms of soft skills. To do so, make sure in advance if your point of contact during the due diligence will also be responsible for you after the investment is undertaken. Try to find out how trustworthy and honest the investor is. He should be your coach and partner not your external opponent. Apart from that challenge him in terms of analytical competence. Does he quickly understand your business model and the challenges underlying it? Does he or she focus on the important topics driving business success? There are many personal character traits you should observe, also depending on what is important to you and your team. Overall, a new investor should fit your team culture and attitude.
How to assess a VC
A professional investor will elaborate a profound due diligence. This will include spending lots of time with you. Use that time to do your own due diligence on him or her. Also ask questions and have a dinner and a beer after a longer workshop session. Moreover, use your network to get some insights on the investor. Every good VC will offer you references of previous investments you can call. If not, ask for it. If there is nothing to hide, he or she will be more than willing to support your request.