So You Want to be a VC — Customer Screening

(N.B. I was recently invited to write a series of guests posts for Tech In Asia, focusing on high level approaches to investing in startups. Below is the first of the series. Some of you might find this rudimentary, others may find this extremely helpful, but hopefully all of you will get something out of this. Original article here.)

As an outside consultant to the startup ecosystem, I frequently work with investing entities on their deal flow, screening, and due diligence process.

There are as many different styles and approaches as there are VC firms, and each person has different aspects that they emphasize. Some focus on people, others on technology, and others on the business. Over time, I’ve been exposed to numerous methodologies and have developed my own as well.

One thing I learned is that you can often get more relevant information from a startup’s customers than in any pitch deck or presentation. But customer screening is frequently overlooked and often not properly done.

The typical approach of an investor is to ask customers a laundry list of questions like:

• Are you happy with the product?
• How long have you been a customer?
• Why did you choose this product?

These are good questions — especially the third — but I prefer a deeper approach.

Building a customer story

Try instead to build a story from beginning to end with open-ended questions.

Let’s say you’re screening customers for a B2B startup. Start with how the startup’s customer (a company, in this example) recognized there was a problem. What was the best existing alternative solution/process to solving that problem before the startup came along?

Then, work your way through the following:

• How/why the company chose the product
• How they integrated it
• If they have implemented it fully today
• Who is using it now
• If they are satisfied
• How/why usage has changed over time
• What they’d want from the product in the future (aka what isn’t working well now)

I typically spend 30 to 60 minutes per call in this process, and always over the phone. Be extremely respectful of the customer’s time and completely transparent. I begin the call saying, “X is considering investing in Y. I would love to have you walk me through your history with Y and when you first realized you wanted a solution.”

By building a full story, the customer can give you insights hidden between the lines of the pitch deck, clue you into additional potential benefits of the product, or bring to light the flaws and issues that otherwise would have been overlooked.

Weighing a customer’s value

But not all customers should be given equal weight. There are different types of customers and ways of acquisition, and these play an important role in the screening process. Below is a hierarchy of customer acquisition methodologies and their relevance to the startup in question.

Best: Public tender

If the startup “won” the customer through public tender, this means they truly have something special that beat out the competition — either in terms of product quality, use case, or pricing.

This means that the customer adopted the product, proving that the product-market fit was spot-on and that the startup was able to answer the call. Bonus points if it was a staged tender (like a run-off election).

Better: Hardcore, boots-on-the-ground business development

If the customer was “won” through the classic business development path, then this means the startup did some extensive legwork to pursue them, effectively getting them through a long sales cycle and eventually converting them.

This is a good indication that founders have the stamina and hustle to stay in the game for the long run and work with customers to hone the problem/solution and product-market fit.

Decent: Proof-of-concept-partner-turned-customer

In my experience, most Beta/proof-of-concept (POC) partners emerge from preexisting relationships. Either the founders knew the partner personally or were connected to them through their network or accelerator/incubator.

This is a well-established approach to getting a foot in the door. Typically, the Beta/POC customer is willing to work with the startup on product-market fit. The frequent issue with this is that the startup has created a product that works for only one customer, which means the kinks aren’t ironed out to work for many customers.

In a sense, the startup has created a customized product and may have difficulty moving on from the Beta/POC partner to actual customers.

So-so: Sign-ups at conferences/events

Many startups gain their first customers through exposure at conferences/events. I personally dislike these mass-market events, but they are a necessary evil.

Customers at such events are already looking for solutions. However, this also means they are probably dabbling in many others to solve the same problem and could potentially be in beta with a number of different vendors.

So, it’s important for investors to understand if a startup has locked in these customers or if they’re just one of many options.

Bad: Bought/acquired customers

What can you do? Startups need to reel in customers somehow. For many SaaS and B2C companies, the best way to do this — and the lowest hanging fruit — is through paid ads, SEO, and marketing in general. These customers are fickle, and churn could be a huge potential problem.

So, when dealing with such customers, an investor must understand their motivations for the future and keep track to see if they stick with the product or not.