Founder-investor relations #2: How to do your investor due diligence
My observations of more than 60 unique founder-investor relationships at Speedinvest have made me realize how big an effect the personalities of the people involved have. In this blog series on the basics of a good founder-investor relationship, I want to share factors and best practices with the aim of ensuring that all founders get the same opportunities.
A good investor will appreciate you not taking any money you‘re offered but that you also look into factors such as an investor’s reputation and network and their core values. Read my last blog post on which factors you should watch out for in a potential investor. But how do you make sure that you’ve truly found the right investor?
The process of choosing your investor is in fact very similar to how early stage investors choose the startups to invest in: do online research to get an understanding of their values and performance, get references from stakeholders that have worked with them and observe them directly during your interactions.
1 Get a basic understanding of who your investor is
There are two main things you can find out about your investor online even before the first meeting: their core values and their public reputation.
Key values can be found in words that are repeated in every interview and article
Check the investor’s website as well as other resources such as blogs, interviews and articles to understand what kind of investor you’re talking to and what is important to her.
A quick glance at the a16z website makes it very obvious that they’re following a hands-on platform approach: they offer a plethora of advice in various categories from human resources, product management and go-to-market to boards and fundraising. Same goes for us / Speedinvest: everything we have written on our website was carefully curated, and it reflects our internal priorities to the point. We don’t have a manifesto on our key values or something of that sort, but check our website and any interview of ours, and it will always include the terms “hands-on”, “founder-friendly” and “entrepreneurial”. Find the investor that matches your values and expectations.
Reputation and performance
The main reason you want your investor to have a good reputation in the investor scene is that it influences her ability to help you with follow-on fundraising. Remember that VC is a long-term business: it takes 5–7 years for a fund to show performance. However, startups that are backed by reputable VCs are significantly more likely to raise follow-on fundraising: CB insights found that 51% of Seed-stage companies that were backed by “smart money” went on to raise a Series A, in comparison to an overall follow-on ratio of only 35%. So, how to find out what reputation the fund has?
There are lots of investor rankings out there, mostly for specific geographies or verticals, e.g.:
- Dealroom: Europe’s 500 Most Prominent Venture Capital Investors
- CB Insights: Europe’s Top Venture Capital Investors by Country
- Forbes: 2017 MIDAS List
Since reputation can’t be directly measured, most rankings use a mix of different proxies, e.g. amount of investments, amount and sizes of exits, amount and sizes of funds raised, ratio of follow-on investments etc. Make sure you understand what the ranking is based on, and be sure to prioritize quality over quantity. And, even more importantly, lots of things cannot be found in a list or online resource, which brings me to the second point:
2 Ask people in the network for references
Make sure you also do reference checks in your network and reach out to founders of existing portfolio companies to understand what it’s really like to work with the investor. Keep in mind that you will be talking to people who have an ongoing working relationship, so they will obviously not be incentivized to speak negatively about the other side. The same thing happens to us investors when we speak to your customers and other people you’ve worked with. I’ve never received outright negative feedback about a founder or business in a reference call. But you can read between the lines (listen to what is not said!), and it’s especially important to ask the right questions. The more concrete your questions, the more difficult it will be for the other side to paint a false picture. Good questions include:
- Why did you choose your investors?
- How have they been instrumental in your success?
- Have they at some point made you rethink your business model assumptions or strategy?
- How often do you talk to your investor?
- What could they change to be an even better investor?
- How do they react when things become difficult?
Also, prepare questions that are investor-specific (e.g. for Speedinvest that would be a question on the “Growth Partner Program”).
By now, you should already have a good external idea of what your potential investor is like and you will probably be quite far along in the investment process (hopefully needless to say, but: don’t waste your time doing the aforementioned reference checks on investors who are not interested).
3 Observe the investor in day-to-day interaction
Since the investment process usually takes around two to three months, you’ll already have some first-hand experience of what it’s like to work together with the investor before you actually sign the contracts. Two crucial things you should take close notice of are the day-to-day operational responses and the behavior in term sheet negotiations.
How long does it take the investor to respond to your emails and call you back? Do they ask the right questions about your business and is their feedback helpful? How transparent are they about their investment process and the next steps in their due diligence? All these points are important indicators of how they will be working together with you once you’re a part of their portfolio.
Finally, the term sheet negotiation is probably one of the most crucial steps in understanding the type of investor you’re interacting with; it’s also one of the last possibilities to withdraw from the investment process. Only you know what is important to you, but make sure you check the standard terms and understand what they mean for you as a founder and for your company. There are loads of resources on this, so make sure you do your homework diligently especially if you’re a first-time founder (e.g. this blog series). Is the investor willing to engage in a discussion with you or does she want to force terms on you? If at any point during this process you feel that you can’t trust the investor, or if any red flags are raised, you should be wary. I believe building and maintaining trust is crucial for a working founder-investor relationship, and an often overlooked factor (read more about this in a separate blog post).
Choosing is a key concept in venture capital: show the investor that you, too, can be picky. Make sure you also tell the investor that you’ve done due diligence on them: it underlines that you (a) have a choice in who you will take money from, (b) are pro-active and don’t shy away from reaching out to people, and/or (c) have a good network yourself. As a side benefit of this process, you can make the investor feel good about herself. I’ve had founders congratulate me on our “spotless” reputation and that our portfolio companies “love” Speedinvest. It’s actually a nifty psychologic trick where people associate the compliment with you, and it totally works (it’s called “trait transfer”): I instantly liked the founders more for it.
Disclaimer: I’ll admit that I’m biased in my view of Speedinvest (simply because I truly believe in our team and model) and I’m happy to discuss all of these points. Send me your thoughts at email@example.com!